Home / Opinion / Views /  Opinion | The intricate balance of interests struck by RBI

It was a tough rate call for the Reserve Bank of India (RBI) on Thursday, with a contracting economy and high inflation pulling its decision in opposite directions. Eventually, the latter prevailed. RBI left its repo rate unchanged at 4%. This is the rate at which it lends overnight funds to banks, and it has already been slashed by a cumulative 2.5 percentage points since last year. The central bank’s rejection of demands for yet another rate cut was backed by a sound rationale. Average inflation has been above the 6% upper bound of its target range for two consecutive quarters. This means its chief policy rate was already negative in real terms. A cut below 4%, also the midpoint of its inflation target, would have sent a red alert to savers worried by falling rates, and, that too, without doing much good for an economy that is stricken by corona uncertainty and weak demand, not by a problem of unaffordable credit. Thankfully, the central bank made it clear that price stability must return before money is eased any further. This stance should remain conditional.

Instead, the central bank has sought to aid the economy in other ways. As a relief measure, a one-time recast has been allowed of some loans that could have gone bad once the current repayment moratorium is lifted on 31 August, for example, with an expert panel asked to determine how such debt should be reworked. Also, a tweak of capital requirements will make it easier for banks to pick up corporate bonds. What should cheer Indian savers, meanwhile, is that their concerns retain salience in the setting of monetary policy. Most rely on bank deposits not to lose value to the corrosive effect of inflation on the rupee’s purchasing power. As prices rise and deposit rates fall, what people withdraw from their accounts is often worth less than the money they put in. Though savers rarely track inflation closely, and don’t mind losing a little so long as their money is safe, a brazen policy of financial repression could have adverse consequences. It could prompt savers to move money into risky investments, for example, and such rash behaviour among large numbers could result in misallocation of capital across the economy.

A rate cut would have stimulated private investment and spending had these variables been a clear function of capital costs, but that link seems particularly tenuous right now. In any case, lenders are not short of funds, going by the money they park daily with RBI (and the earnings forgone in this exercise). Unless risk aversion eases among banks and demand goes up in sundry markets, cheaper loans will not spur an economic revival. Fiscal outlays that translate into expenditure would be far more useful. As it happens, however, too many of us seem conditioned to see monetary policy as a panacea for all that ails an economy. This can be traced to a monetarist revolution that gained force globally in the 1980s. If growth slowed, rates were cut. And if inflation rose, they were raised. But the limits of monetary responses to unusual crises have grown apparent, too. Of course, India has complexities of its own that render policy rates relatively ineffective. Poor data quality presents another set of riddles. For instance, it could yet turn out that inflationary pressures are not as bad as they seem. We have had shocks of both supply and demand, after all, and the price outlook looks decidedly hazy today. There is much that we do not know. But, given all that we do know, RBI has been assuredly prudent.

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