Monetary policy is usually formulated under the shadow of various influences. Multiple shadows have cast a pall over Shaktikanta Das’s maiden monetary policy as Reserve Bank of India (RBI) governor and the Indian central bank’s sixth and last one for 2018-19. The shadow of imminent elections looms largest over the political economy, especially after the interim budget’s unabashed display of courtship with diverse voter-bases such as farmers, unorganized labour and the salaried middle class. It might, therefore, be tempting to view the RBI’s reduction of benchmark repo rate by 25 basis points (one basis point is a hundredth of a percentage point) and change in stance (from calibrated tightening to neutral) as a continuation of the government’s election strategy. Coming as it does on top of an easy liquidity situation, or sticky core inflation, the RBI’s accommodative stance is bound to invite adverse political comment. However, the reality is perhaps slightly more nuanced.
An undertow of anxieties marks the central bank’s monetary policy. A perceptible economic slowdown since the last bimonthly monetary policy in December and a palpable change in tone, largely bordering on the cautious, colour the current monetary policy document. The RBI has marginally scaled down its gross domestic product growth projection for the first half of 2019-20. In December, the policy document had contended that the output gap has “virtually closed". This time it notes that the gap has opened up “modestly". Top-line growth in many industries, including high-frequency indicators such as passenger car sales and air passenger traffic, has remained subdued over the past two months. When combined with decelerating food prices and stagnating rural wages, including moderation of agricultural incomes, it is cause for worry because a falling price-line tends to freeze economic decision-making. Equally or more worrying is the fact that the government’s pump-priming has failed to yield desired outcomes. Private investment continues to remain a reluctant participant in the economic growth process. All this indicates a sense of despair in the polity and heightened risk perception impeding private investment.
However, the key question is: Will a rate cut help turn the tide? The Indian financial system’s gummy transmission channels famously display an asymmetric response to monetary policy stimulus. It is well-known that lending rates adjust faster to monetary policy tightening than to loosening, with deposit rates acting in the opposite direction (quick to come down in response to monetary loosening but slower in reacting to tightening). Faced with this reality, the RBI is also trying to nudge growth by opening the credit sluice gates, markedly for finance companies and agriculture. In addition, three large public sector banks have been de-sequestered from lending restrictions. The outcome will depend on the balance of methods Das employs to induce the system’s financial agents to disregard risks and start lending again—through a process of moral suasion that was a preferred mechanism in the past, or through systemic benchmark action (such as repo rate changes) or a combination of the two.