Reserve Bank of India (RBI) governor D. Subbarao has surprised the bond market and most economists by hitting the pause button. These columns had argued in favour of a modest cut in policy interest rates amid declining growth and inflation—which was more or less the consensus view in the days before Subbarao announced the third quarter review of monetary policy, when the RBI governor tends to make major policy decisions. This newspaper’s Banker’s Trust column, on the other hand, had argued that the central bank could wait before it reduces interest rates again. That is precisely what the central bank eventually did on Tuesday.
Subbarao’s monetary policy statement leaves no doubt that times will continue to be tough this year. The subtext of his long statement seems to be that it is sensible to conserve some firepower if there are more shocks to the global financial system and the domestic economy.
RBI has been aggressively cutting interest rates and flooding the domestic financial system with liquidity in a bid to fight the contagion that has spread through the world because of the problems in the Western financial system. There could be further shocks in store. But it is more likely that central bankers will be busier in 2009 fighting recessions than in keeping banks solvent.
Most governments want interest rates to come down and public spending to increase to battle recessions and slowdowns. The problem is that the cost of money is dropping to levels where it cannot be further reduced even as fiscal deficits rise to dangerous levels. Further drops in interest rates and increases in deficits could lead to macroeconomic imbalances that can spur a few sovereign defaults this year.
India will be caught square in the middle of these convulsions. There could be a few more gut-wrenching episodes of volatility this year and RBI has reason to want to conserve some firepower for the months ahead.
But this leads to a disturbing question: Were the huge interest rate cuts since October overdone to an extent that India’s central bank now only has pellets rather than bazookas in its armoury?
Does Subbarao need to preserve ammunition for the next stage of the crisis? Tell us at firstname.lastname@example.org