The Economist wrote a leading article recently (http://www. that the incredible story of India has ended for now. In it, the editors of this “newspaper" had said that India was unlikely to keel over because of a cloistered financial system, ample foreign exchange reserves and a capable central bank. The central bank proved itself to be capable on Monday when, contrary to all the din and noise for a rate cut, for a reduction in the cash reserve ratio, the Reserve Bank of India (RBI) held its nerve and left the cash reserve ratio and the repo and reverse repo rates unchanged. It has vindicated the lead article in The Economist.

One of my friends pointed out that, throughout last year, RBI had raised interest rates because the core inflation rate—the rate of inflation in non-food manufactured goods—was rising. Now that the core inflation rate held steady at around 5%, RBI had room to ease. After all, the economy had contracted in the first quarter, sequentially and the annual growth rate had dropped to a meagre 5.3%. On top of it, the real lending rate (deflated by the inflation rate measured by the Wholesale Price Index) was too high and the real deposit rate (deflated by the inflation rate from the Consumer Price Index) was too low.

Rate of credit growth has slowed. Annual credit growth to the commercial sector (non-food credit) was 17.1% in May. Both in comparison with history and in a normative sense, credit growth can and should pick up for capital spending to revive in India.

So, how does one bring down the real lending rate and raise the real deposit rate at the same time? For both, the solution lies in fiscal policy. Inflation will be lower if fiscal policy were appropriately contractionary. That would also help to lower nominal benchmark rates and lending rates can drop.

It is almost the end of first quarter of the new fiscal year in India (April 2012-March 2013). The government has not addressed the ample fiscal concerns evident to all at the start of the fiscal. There are always excuses for not doing the right thing at the right time. We were told that the government would lower subsidies on petroleum products after the budget session of Parliament got over. Nothing got done. Now, we are told that diesel prices would go up after presidential election in July.

In fact, the fond hope is that there will be a political realignment after the presidential election, with the Samajwadi Party replacing the Trinamool Congress in the governing coalition at the centre, paving the way for difficult regulatory and administrative reforms and economic liberalization measures. The mistaken assumption is that the Prime Minister is genuinely committed to economic reforms. But this government has belied expectations too often for monetary policy to be conducted on the basis of hopes. The single most important reform signal that this government can send is to disband the National Advisory Council. That is unlikely to happen.

Central bankers are paid to be prudent and not run policy based on optimistic assumptions. It would be appropriate for RBI to wait and see what the political class delivers on budget deficit reduction and on economic reforms before it lends its supporting hand. We should not forget that RBI delivered a 50 basis points (bps) rate cut in April and, as JPMorgan points out, the recent depreciation in the Indian rupee amounts to another 50-100 bps of rate reduction.

The Indian monsoon season that runs from June to August is only a fortnight old. These are early days. But the rainfall shortfall is 40-plus % for the nation. If the trend of deficient rainfall persists, it will bolster inflation expectations further.

Further, although the Indian crude oil import basket is down 17% from its peak on 26 March, the outlook for the price of crude oil remains highly uncertain. The death of the Saudi crown prince, the alliance forged by Iran and Iraq in the Organization of the Petroleum Exporting Countries and the potential for monetary stimulus from the US and Europe lend upside risk to the international price of crude oil.

RBI has done well and Indians should be grateful for a clear-headed central bank.

V. Anantha Nageswaran is an independent financial consultant based in Singapore. Comments are welcome at

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