Has the time come for the Reserve Bank of India (RBI) to take calibrated risks? Monday’s inflation figures would suggest not. Wholesale-price inflation rose 7.81% annually from August’s 7.55% as the September diesel price hike passed through. July inflation was revised to a much higher 7.52% as well. Core or non-food, manufactured goods inflation, which is what figures in RBI’s reaction function, remains sticky at 5.6% year-on-year: the price increase here is broad-based, the monthly momentum is 0.6% when stripped of seasonality, and looking ahead, the second-round effects of fuel price adjustments remain in the offing.
What does the central bank do with such price statistics when a sluggish economy pricks its conscience and there’s political encouragement to take a risk? Does monetary policy get induced to risky actions? For the record, since RBI’s 50 basis points policy rate cut of April, core inflation, which was 5% in March, has risen and remains elevated. There is little evidence of a sustained decline in price pressures that would justify monetary easing at this point. One basis point is 0.01%.
On the growth front, the forward-looking manufacturing purchasing managers index suggests some stabilization of real economic activity. The index remained unchanged at 52.8 in September with improvements in both domestic and external demand sub-components. Recent trade data corroborates this somewhat: overall import growth turned positive on an annual basis, while the sustained, five-month contraction in non-oil import growth moderated significantly. Likewise, industrial output figures showed a 2.7% year-on-year rise in overall production in September after a two-month decline, although it is too early to detect any trend from this indicator.
Returning to monetary-fiscal coordination to revive growth, demonstrated fiscal action is so far confined to an increase in diesel prices that marginally subtracts from the overall budgetary deficit. The critical components of quantitative significance – spectrum auction and disinvestment revenues – to impact the fiscal deficit are yet to unfold. Relaxation of investment rules, tax reforms to expand the revenue base and clarification on other tax matters are all of medium-term significance where public balances are concerned. Such resolves matter little for monetary policy, which is set on much shorter time horizons.
Monetary policy has already bent with the September cut of 25 basis points in the cash reserve ratio (the portion of deposits banks need to park with RBI) to ease liquidity conditions, prompting banks to lower interest rates even as RBI’s monetary stance stays hawkish. Significantly, there are strong indications of New Delhi’s preference for exchange rate appreciation. Does this suggest a larger weight on the exchange rate tool and consequently, lesser burden on interest rates in deciding the mix of monetary tools ahead? One hopes that the lower interest rates-strong exchange rate combination in an environment of high inflation, strong capital inflows and enlarged current account and fiscal deficits is not repeated again. RBI should not be easing interest rates when the fiscal performance criteria remain unconvincing.
Renu Kohli is a New Delhi-based macroeconomist; she is a former staff member of the International Monetary Fund and the Reserve Bank of India.