In its mid-quarter monetary policy review on Monday, the Reserve Bank of India (RBI) kept monetary conditions unchanged. After its surprising 50 basis points (bps) cut in the repo rate in April, a build-up of expectations for a further cut had occurred in the past two months. Instead, the central bank chose a course of prudence in the face of renewed inflationary pressures; and rightly so.
One key reason for not further loosening monetary policy is the government’s inability to take matching steps after RBI’s last round of rate cuts. The bank noted: “The Reserve Bank had front-loaded the policy rate reduction in April with a cut of 50 bps. This decision was based on the premise that the process of fiscal consolidation critical for inflation management would get under way, along with other supply-side initiatives. Our assessment of the current growth-inflation dynamic is that there are several factors responsible for the slowdown in activity, particularly in investment, with the role of interest rates being relatively small.”
Since the last policy review, two other developments have taken place. One, the rupee’s continuous depreciation amounts to an effective loosening of monetary conditions.
JPMorgan’s India economist Sajjid Chinoy argued in Mint on Monday that 10% depreciation in the nominal effective exchange rate of the rupee is equivalent to 100 bps of rate cuts. Two, the Wholesale Price Index (WPI) has been above 7% for the past four months. Data released on Monday shows that retail inflation in May stood at 10.36%. With high retail inflation and other important components of WPI—food and fuel—too being in double digits, the possibility of generalized inflation creeping upwards is very real. In any case, if inflationary expectations are a yardstick of what can happen, these dangers cannot be ignored. There is plenty of suppressed inflation in fuel products: at the moment global oil and commodity prices are down, but in case of a further injection of liquidity by Western central banks—something that can’t be ruled out—these prices will shoot up.
Under these conditions, it makes little sense for inflicting further rate cuts. There is widespread fear—especially in industry—that unless the cost of investment is brought down, growth will not pick up. Interest rates are only one measure of these costs. If anything, more than interest rates, time overruns and policy delays are much more important in undermining investment and project viability. The central bank has little to do with these issues. The remedy for this problem lies with the government.
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