It’s finally good to see bold moves from policymakers. Problem is, it’s the wrong set of policymakers. We need bold moves from Delhi — to ease the supply constraints that are at the root of the current slowdown. We don’t need bold easing from RBI when the inflation battle is still to be won, the current account deficit is at an all-time high and the currency is under pressure.
RBI’s 50-bps cut can be construed as the central bank tactically using this narrow window of opportunity – when inflation has gapped down – to frontload the rate cuts intended for the year, knowing opportunities may not come by later.
But this is a high-stakes gamble. Remember December 2010? A moderation in core inflation prompted RBI to pause its rate rise cycle. Only to witness a rude inflation shock in the subsequent months prompting two 50-bps rises in mid-2011. The fear is that history may be repeating itself. By all accounts input costs pressures are still strong and will be compounded by the weakened rupee over the last few months. With food inflation almost back in double digits, and a host of price increases (excise duties, coal, electricity, diesel, freight tariffs) on the anvil, the outlook for inflation is far from benign. Pricing power may well have abated in recent months but if, as the RBI believes, growth is going to accelerate in FY13, then firms will have more headroom in raising output prices and core inflation should rise, not fall. When the base effects wear off, therefore, I expect inflation will head towards 8%, and the RBI may be forced to reverse course again.
The fundamental issue is that monetary tightening is not the principal cause of India’s corporate investment cycle languishing. And therefore cannot be the saviour. The answer lies with credible fiscal consolidation, de-bottlenecking the infrastructure sector, making land far more accessible, and fostering the appropriate regulatory climate.
There is an imperfect substitutability between policy reforms and monetary policy. If policy-makers abdicate the former but instead rely on premature monetary easing in the hope of jump-starting investment, we could re-stoke the inflation monster. And that would be akin to throwing the baby out with the bathwater.
Sajjid Chinoy, India Economist, JP Morgan
