RBI chose to postpone its firefight to another day

RBI chose to postpone its firefight to another day

On this day we had the rupee tumbling to another all time-low. The stock market suffered one of its worst falls ever. The UK reported its first economic contraction in 16 years. The Organization of Petroleum Exporting Countries announced a steep production cut, signalling the end of the go-go years for Big Oil.

Former US Federal Reserve chairman Alan Greenspan, in his testimony before the US lawmakers, admitted that his free-market model was flawed. The financial tsunami, as he called it, was a once-in-a-century phenomenon, and it would leave a lot of destruction in its wake. He was in a state of “shocked disbelief".

Thankfully, this global shock hasn’t paralysed our central bankers into inaction. The swift and proactive measures of the previous weeks are testimony to their readiness. In a slew of measures, RBI attacked the immediate problem of liquidity. With a steep cut in the cash reserve ratio, or the proportion of deposits that banks must keep with the central bank, higher incentive to attract non-resident Indians’ deposits, removal of curbs on external commercial borrowings and temporary access to emergency cash for mutual funds, the liquidity constraints are abating. The medium-term concern is credit. The longer-term issue is investment.

RBI data shows that credit is growing faster than last year, even after discounting the effect of inflated oil company credit (due to higher oil prices).

Another leading indicator of economic health, currency-with-public, is growing 20%, twice the pace of last year. A disaggregated analysis of industrial production shows the consumer goods sector performing well, but all else is slipping. The six-quarter decline in the index of industrial production, or IIP, might be reflecting capacity bottlenecks, and not just demand slowdown. For example, if no new capacity in steel or cement has come up in the last 12 months, it would reflect zero growth in IIP.

Despite some isolated silver specks, the consensus is that growth is slowing. The growth impulse cannot, however, be provided by monetary measures alone. We may get interest rate cuts in the next six months, but we also need to ensure that consumer and investment spending keeps its momentum.

Investment spending grew at close to a compounded annual growth rate of 20% over the last five years, and is in danger of falling to less than 10%. A public sector push in infrastructure is much needed. There is a sizeable burden the public treasury will shoulder this year, and perhaps well into the future. If not outright bailouts, there may be other forms of rescues and fiscal injections. In such a case, a cut in the statutory liquidity ratio, or SLR, the proportion of deposits that banks are required to invest in government bonds, is totally inappropriate. Bear in mind that it is SLR that has ensured bank sector stability at a time when the high and mighty have fallen all over the world. RBI has done well in refusing to buckle to demands that it open the SLR lock. That can be done on another day, when the tsunami is past.

Ajit Ranade is group chief economist at Aditya Birla Group. The views expressed are his own.

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