The global economy is at crossroads. The structural problems faced by all developed economies in terms of high fiscal deficit and high government borrowing, coupled with lower growth, is impacting the growth prospects of all emerging economies, including India. After two successive years of robust growth of 8.4 per cent, India’s GDP growth is estimated to decelerate sharply to 6.9 per cent during 2011-12. The growth of 6.1 per cent seen in Q3 of 2011-12 is the lowest in the last 11 quarters. There are several factors impacting India’s growth — high inflation, high fiscal deficit and government borrowings, weaker currency resulting in imported inflation, lack of reforms, etc.
The central bank is trying to manage the impossible trinity of inflation, currency and economic growth. Till now, RBI had done a commendable job of balancing the trinity by increasing interest rates to contain inflation, intervening in the currency markets to stop currency from drastically depreciating and infused liquidity into the system by reducing CRR by 125 basis points during January to March 2012 to accelerate the growth. However, this seems to be not enough. Inflation continues to remain high, there are concerns about growth decelerating further and the pressure on the currency is increasing due to a continuous high current account deficit.
The key problem is the government’s fiscal deficit. Government is expected to borrow Rs 5.69 lakh crores during the year, which will crowd out private borrowings and investment, while increasing inflation. Without addressing the high fiscal deficit, the other problems in the economy cannot be fixed. The RBI governor had been repeatedly stressing this point. The reduction of repo rate by 50 basis points is a very clear indication that RBI is extremely worried about the growth in the economy.
While its hands are tied due to high inflation and excessive governmentâ€™s borrowings, RBI had taken the bold step, ahead of the curve, to cut interest rates. India is a very interest sensitive economy and this reduction in repo rates will to some extent accelerate the economic growth. However, based on the current and evolving macro- economic environment, any further significant future rate cuts, seems highly unlikely.
Duvvuri Subbarao, the head of Reserve Bank of India, said on Saturday there is room for monetary easing but it is limited, and there were upside ...