Highlighting the risk of a prolonged global downturn, the Reserve Bank of India, or RBI, seems to have hit the pause button after four months of aggressive monetary easing since October.
In the 24 October mid-term monetary policy review, RBI had stated the need to closely monitor the liquidity and monetary situation, preserve financial stability, maintain price stability and sustain the growth momentum in response to emerging global developments.
However, the deepening global financial crisis and the consequent economic downturn have continued to impact India’s growth trajectory and the central bank has revised its gross domestic product (GDP) growth estimate for 2008-09 from 7.5–8% earlier to 7% now, with a downward bias.
As slowing growth will remain a concern, the government and RBI seem to be working in tandem to mitigate pain. Unfortunately, the headroom for fiscal manoeuvrability is limited—the outstanding liabilities to GDP ratio was budgeted to be at 73.4% for the current fiscal. However, with the consolidated (plus off-balance sheet) fiscal deficit now set to breach 7% (versus the budgeted 4.6%), this ratio may even go up to 80%!
This limitation underlines the need for a measured monetary policy stance and is indicated by the central bank’s assurance to “take calibrated monetary policy actions and at the appropriate time”. However, we believe that RBI would not like to exhaust all the ammunition at its disposal given the prevailing global uncertainty.
Overall, monetary easing will continue, albeit in measured doses unlike the big-bang approach adopted since October. RBI has acknowledged the challenges the banking sector faces in adjusting lending rates to policy rates. However, it will take the sector some time to adjust to this sudden and sharp reversal in policy direction since RBI had earlier tightened rates over four years, and the current monetary easing cycle has spanned only four months.
In India, the liquidity shock to the banking sector seen in September-October was soon followed by growing evidence of rapidly declining economic activity, especially in manufacturing. The key challenge for banks will be to channel higher credit amid an economic downturn, which carries the risk of some compromise in asset quality.
In terms of overall macroeconomic conditions, wholesale price inflation is now expected to fall below 3% in the short term due to the high base effect. However, double-digit growth in consumer price inflation remains worrisome. We believe the current wait-and-watch stance may also have been influenced in part by still sustained pressures on food prices, which may face additional upward pressures if money supply continues to expand rapidly.
On balance, on the back of weak economic data, we expect monetary easing to continue to stimulate growth, even as RBI remains focused on maintaining financial stability amid prolonged uncertainty in the global environment.
Shubhada Rao is chief economist, Yes Bank Ltd.