A former governor of the Reserve Bank of India once said that the effectiveness of the apex bank’s policies often depended on how well it managed to spring positive surprises on the markets. There is no doubt that positive news delivered with surprise yields substantially more benefits compared to a policy announcement that either has no surprise element or fails to exceed market expectations. In contrast, bad news is more harmful when it comes as a surprise, compared to a situation when the market has been psychologically prepared to expect the adverse blow.
It would appear that RBI Governor Duvvuri Subbarao has now absorbed this message rather well. A little over a month ago, he surprised the markets by an aggressive cut in the cash reserve ratio, or CRR, by 75 basis points (bps), that eased liquidity considerably by releasing an estimated Rs 48,000 crore into the banking system. Coming as it did just five days before the mid-quarter review of monetary policy due on March 15, the markets were pleasantly surprised. Nobody expected a cut in CRR then, and that too by that steep a margin. It was a positive surprise and did improve market sentiments.
Not surprisingly, the move had also raised expectations of a repo rate cut in his mid-quarter monetary policy review. However, Mr Subbarao did not oblige the markets then — and instead indicated that the movement towards easing monetary policy could be expedited if the government unveiled a credible fiscal adjustment programme in its Budget the following day. The Union Budget disappointed the markets as its fiscal correction programme was not bold enough to inspire any confidence, and whatever was targeted lacked credibility.
For instance, a modest outlay of Rs 40,000-odd crore was provided in the Budget to meet the oil marketing companies’ subsidy bill. With no plan in place to raise petroleum product prices and given the stiff political opposition to such a move, the Budget’s provision for petroleum sector subsidies appeared hopelessly inadequate to meet the actual demand that analysts estimated to be more than four times that figure. Even on the revenue side, the numbers looked ambitious. Disinvestment proceeds were estimated at Rs 30,000 crore, even though the government at the peak of the stock market rally could claim an annual receipt of only about Rs 22,000 crore under this head. Telecom spectrum fee also appeared to have been overestimated.
On the other hand, the global outlook has remained uncertain. Even though commodity prices have declined across international markets, crude oil has remained firm and is still a cause for concern for import-dependent countries such as India. With the impact of the Budget’s increase in indirect taxes yet to be fully reflected in product and service prices, the incipient inflationary pressure in the domestic economy could resurface any time. Yes, the inflation rate has declined, but it is still above the 4-6 per cent level that the central bank itself considers comfortable for the Indian economy. In addition, there are worries on the balance of payments front, with the current account deficit likely to widen to around four per cent of gross domestic product.
And yet, there was a view that perhaps because of the RBI’s preoccupation with maintaining a tight vigil on inflation, the central bank had ignored the economy’s concern for growth and had refrained from cutting the repo rate for about three years. So, the markets and a large body of economists were in favour of a marginal cut in the repo rate, perhaps by 25 bps, just to send out a positive signal to industry. A 25-bp cut in the repo rate yesterday, therefore, would have only met the market’s expectations. Instead, the RBI governor surprised the markets with a 50-bp cut in the repo rate.
The markets did react with enthusiasm to the RBI move. But soon the larger message of the 2012-13 Monetary Policy Statement dawned on the markets. Along with the repo rate cut came the implicit suggestion that industry or markets should expect no further cut in the rates unless the price situation gets under control. Even before the repo rate cut decision could result in a decline in the banks’ lending rates, the central bank quietly hinted that the rate cut season had already come to an end.
Make no mistake about that message. If the government does not reciprocate with necessary policy initiatives to fix the fisc and remove bottlenecks in fresh investments, the monetary policy is not likely to see any further easing. Finance Minister Pranab Mukherjee could not have missed that signal, even though the RBI governor may have been a little guarded about his comments on the fiscal policy authority. Who knows, Duvvuri Subbarao may have been inspired by an old Sanskrit saying that goes like this: speak what is true, speak what is pleasant, but speak not what is unpleasant even though it might be true.