To do or not to do was the big question the RBI Governor answered rather emphatically. When RBI began its rate- tightening cycle in March 2010, India’s GDP growth was appearing stable at eight per cent, despite global uncertainties and elevated levels of inflation.
The US economic recovery was nascent at best and the euro zone crisis still a riddle. The central bank, then, decided to shift to one extreme of its dual mandate and focused its policy actions towards curbing inflation. Today, 13 rate increases later and after repeated calls to the central government to curtail its fiscal largesse, inflation is still above the central bank’s comfort zone and growth worryingly modest.
Growth in the US still suffers from a drag of housing and oil prices and euro zone is surviving on the ECB’s liquidity cushion. These developments have posed a classic policy dilemma for the RBI, to choose between a pro-growth stance and a pro-common man stance, fighting inflation even at the cost of growth.
It is my belief that RBI’s monetary action of cutting the policy rate by 50 basis points gives a strong signal about the change in stance of the central bank. Given a weakened position of the government in supporting the sagging economy, RBI’s measures will help revive sentiment and confidence in the local economy. Growth is back on RBI’s agenda notwithstanding concerns on latent inflation pressures. It is up to the government and policymakers to take a cue and move with purpose and speed. A lot of follow-up actions would be required, if the change in sentiment needs to be translated into tangible benefits. Through the period 2003 to 2008, we have witnessed the strong correlation between credit growth, investment momentum and overall economic well-being. We need to rediscover this phase all over again.
Having cut the repo rates by 50 bp, RBI has dealt with the cost part of the equation. This has to be followed up with measures that will encourage liquidity creation and capital formation. Yield curves should witness correction at the shorter end. Industry would expect the banks to respond with reduction in the lending rates. Steps to relax ECB guidelines will provide the much needed relief to the liquidity situation.
While it is important, interest rates alone do not drive investment decisions. Government has to pay heed to the calls for fiscal prudence and capital allocation accountability. All good intents on improving current account and fiscal deficits must be acted upon. It is only then that RBI will feel justified in the bold step that they have taken.
R Shankar Raman, Chief Financial Officer, Larsen & Toubro
