The mid-year review of the Reserve Bank of India, or RBI, was important even for investors and businesses. One, it is the first policy announced by the new governor, D. Subbarao. Two, it is the first policy following the recent unexpected and sizeable 100 basis points cut (one basis point is one-hundredth of a percentage point) in the repo rate (the rate at which RBI infuses liquidity into the system) that essentially reversed the monetary tightening of recent years. Three, it is the relevant opportunity for the central bank to explain its actions in recent weeks, irrespective of where the recommendations originated.
Unfortunately, the policy statement appears to signal business-as-usual and seems to emphasize that all-is-almost-well, though it did flag some global concerns. Either the central bank is misreading the unfolding situation or, if it is aware of the problems, it does not want to communicate these concerns. Either way, it is not a comforting situation for observers who were waiting for a combination of wholesome analysis and further action.
Strangely, RBI is still emphasizing concerns over inflation, while the world at large—including India—is more likely to face a deflationary shock via unprecedented deleveraging. In any case, the reported public comments from the government on inflation appear to be at odds with RBI’s assessment. Further, if the central bank is so concerned over the inflation outlook, what explains the 100 basis points cut in the repo rate and continued assurances to banks that liquidity conditions will not be tight?
Three questions arise on digesting RBI’s mid-year policy statement: (1) Do quarterly policy reviews now have any significance? (2) Is the central bank sufficiently aware of the worsening global and domestic economic backdrop that has significantly increased downside risk to growth? and (3) Are the underlying macro pressure points so benign that RBI can afford to maintain the status quo? At a time when uncertainty is on the increase, the policy statement does little to comfort.
Most surprising, perhaps, is that the central bank has given no indication about a change in the operational policy rate, which, in my opinion, has shifted to the reverse repo rate from repo rate previously. RBI’s money market actions suggest this shift, but it wants to keep it a guarded secret. Banks have been hit hard enough by the liquidity squeeze, and are unlikely to move to cut rates meaningfully unless that policy rate signal is announced.
It is almost a foregone conclusion that RBI will have to cut the cash reserve ratio, the proportion of deposits that commercial banks need to keep with the central bank, and policy rates very soon, and also ensure sufficient liquidity to ensure that overnight rates hug the reverse repo rate. These moves will likely be inter-meeting, given that the next quarterly review is scheduled for 27 January. Too bad that the policy review generates more questions than answers. RBI needs to appreciate that anything short of the mother-of-all-monetary-easings will be inadequate to prevent a significant downside to growth next year. The clock is ticking.
Rajeev Malik is head of India and Asean economics at Macquarie Capital Securities, Singapore. The views expressed are his own.
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