RBI governor D Subbarao (file photo)

His insights were: one, everyone knows what needs to be done, the problem is political gridlock. Two, there’s no such thing as decoupling. Three, emerging market economies have been affected by the crisis in the euro zone, the slowdown in the US through risk aversion, slowing exports and lack of confidence, which could hurt investment and growth, which in turn could lead to bad loans at banks.

He then, rather ominously, compared the current crisis with the Lehman one and said the situation was better then, because there was global co-ordination between policymakers, aggressive fiscal policy was an option, emerging market and developed economies were at the same stage of the business cycle, and while the public sector rescued the private in 2008 in the advanced economies, the public sector is now the focus of the crisis.

But will the crisis force a change of monetary stance by RBI? The speech shows Subbarao is not underplaying the magnitude of the crisis and recognizes that it will affect growth in India.

At the same time, he also thinks accommodative monetary policy in the developed world was keeping commodity prices unduly high. He says, “The negative outlook on growth should have driven down prices, but that has not been evident so far to any significant extent." In other words, the slowdown in global growth may not lead to lower commodity prices and lower inflation. His remark that emerging countries are at a different stage of the business cycle hints at a restrictive monetary stance by emerging market central banks.

There’s also another issue the governor didn’t touch upon in his speech—the impact of rupee depreciation. This factor may offset the impact of lower global commodity prices. Further, it’s very likely the government’s disinvestment programme will be hit and that, combined with the slowdown, could affect the fiscal deficit. That would be another reason for RBI to not change its stance.

Nevertheless, recent events have fanned hopes that RBI may decide to pause at its next meeting. Indranil Pan, chief economist at Kotak Mahindra Bank Ltd, says that in the past, the central bank has always paused when the inflation trajectory started coming down.

Pan also expects that European policymakers will tie up funding for Greece in October, which could result in a rebound in the risk appetite. While that may be fleeting, it’s significant that while Subbarao mentions that policymakers do not have the luxury of using expansionary fiscal policy today, he remains silent about the monetary policy, implying that if things get sticky, there’s plenty of room to cut interest rates fast.

That will provide support to the downside in the markets. But the trouble today, as it was after the Lehman crisis, is the threat of forced liquidation, as funds raise cash to meet redemption by selling assets. That has driven down prices of all assets in which investors were long. Look, for example, at gold. Look also how overweight markets such as Indonesia, Russia and China have been affected much more than the underweight Indian market this month.