What has the Reserve Bank of India signalled by the 25 basis point cut in the cash reserve ratio? Certainly not a shifting of its concern from inflation to growth. The policy document underlines that inflation is far from being beaten. Indeed, with headline as well as core inflation moving up in the August wholesale price index and with monetary easing by the US Federal Reserve and the European Central Bank pushing up commodity prices, the central bank would have been hard put to justify a rate cut. Moreover, the Reserve Bank has also been saying that real lending rates are already low.

What then of the government’s hiking of diesel prices and the reform measures recently announced? Well, the fuel price hike improves the fiscal position marginally. Also, the Reserve Bank explains its position tellingly when it says, “In April, the Reserve Bank implemented a frontloaded policy rate reduction of 50 basis points on the expectations of fiscal policy support for inflation management alongside supply-side initiatives for addressing the deceleration of investment and growth." In other words, the central bank is saying that it had already reduced its policy rate in April in anticipation of policy action. All that has happened is that the long-delayed policy measures have finally been announced.

To be sure, the policy document also says that the government’s recent actions have improved the growth/inflation balance by shifting expenditure away from consumption by reducing subsidies and towards investment by opening the window for foreign direct investment. But it goes on to say that “as policy actions to stimulate growth materialize, monetary policy will reinforce the positive impact of these actions while maintaining its focus on inflation management." So the policy actions have to be implemented and inflation will have to come down before further monetary policy action.

Why then did the RBI cut the CRR? The document explains that credit growth in the second half of the fiscal might be higher than deposit growth and there could be a pressure on liquidity in the next few weeks on account of advance tax outflows and festival demand for currency. It’s also a signal of support to the government’s measures, although at the same time the central bank is saying current conditions hold it back from doing more. The trouble is, the RBI hasn’t really indicated that it’ll cut rates further ahead either----that too will depend on what happens to inflation.

The CRR cut will enable banks to reduce lending rates a bit more. But that is unlikely to be a factor in improving investment demand. For that to happen, the government will have to ensure that projects that have been held up are kick-started.

What about the markets? While the Sensex has been subdued, there’s a sharp dichotomy between the defensives, where profits are being booked, and the beaten-down rate-sensitive sectors like realty, banks and capital goods. As for the bond market, the lack of credit growth will continue to force banks to buy government securities, keeping yields soft.