The annual policy statement of the Reserve Bank of India (RBI) is, to my mind, exceptionally cautious. It posits a growth rate of “around 6%” for 2009-10. Previous statements going back to 2005 have alternated between half percentage point and the descriptor “about”. So perhaps one should not read too much into the phraseology. But it is self-evident that RBI envisions something less than 6% as a possibility.
Unquestionably this is a tough year with a global recession and a financial crisis and it has been argued that the developed world will not be out of the woods even in late 2009. But that is not the unanimous opinion and there is an emerging consensus that the US economy is at least getting “less bad”, to paraphrase Federal Reserve chairman Ben Bernanke’s words that “decline in economic activity may be slowing”. The Indian economy has been hammered—as have other emerging economies—by the fall in global demand for exports and drying up of investment flows. That the Indian economy would slow in 2009-10 is a given. The question is by how much?
Is 6% too high or too low? This columnist sees this as too low.
RBI has, with the exception of April 2008, underestimated eventual gross domestic product (GDP) growth by 50 basis points (one basis point is one-hundredth of a percentage point) to as much as 250 basis points. So does it matter? I am afraid this time it does. In 2005-06 through 2007-08, large infusions of liquidity from outside, buoyant global conditions and upbeat sentiment provided the necessary financing. These conditions are absent today and central bank and public financing will play a more pivotal role in funding growth in 2009-10. If the central bank shoots for 6% and that is where public policy is targeted—more likely than not—we will undershoot that target.
That said, if economic conditions improve, as they are likely to in the second half of 2009, presumably the central bank will adjust its parameters. That is, put Plan B to work.
A major problem, as many would have guessed, is the uncertainty with the elections—since what the economic policy, instruments and priorities will be, is the preserve of the government to be formed after the elections. The RBI, like the rest of us mortals, has to wait for that to transpire. In the interim it has, to my mind, chosen to play a low hand. Using a lower GDP growth number “for policy purposes” is helpful. For then the funding needs are less and the possible conflict between public and private needs is more easily smoothened out.
When the new government assumes office, hopefully, it will be a coherent one; in which case it will not be satisfied with 6%. Then, presumably we will see Plan B rolled out: Which is why I hope that it exists.
Finally, the reverse repo. Banks have been parking well over Rs1 trillion daily in the central bank’s reverse repo window, offsetting a large part of the liquidity injection instituted by RBI through cuts in the cash reserve ratio, the proportion of deposits banks have to maintain with the central bank. For one thing, banks are earning a large negative spread on this and they would earn much more even if they bought dated government securities.
More importantly, should not the central bank consider putting a limit on the reverse repo (as it had done during March-July 2007) to ensure that the liquidity that it has created by policy stays in circulation?
Saumitra Chaudhuri is economic adviser, Icra.