<p>The Reserve Bank of India (RBI) has chosen to hold both the repo rate and the cash reserve ratio steady. There are reasons why it might have thought that monetary loosening is a bad idea. Prominent among them is the concern that the euro zone will not be able to get its act together on Greece quickly enough to ensure that liquidity does not freeze up worldwide the way it did in 2008. It might be keeping its powder dry for that eventuality. Indeed, it has explicitly warned against the possibility of a global “event shock” that would cause other central banks to flood the market with liquidity in response — which it fears would flow into commodities, raising commodity prices and domestic inflation. There is also, no doubt, the valid concern that government borrowing continues to be high, and the consequent crowding out renders monetary policy relatively ineffective. In addition, the RBI could point to consumer price inflation, which has hardened at over ten per cent, well out of its comfort zone.
However, it has taken the wrong call. Lending rates should have been reduced. Inflationary pressures apart, it should have looked at core inflation — the change in prices that are neither food- nor fuel-based, and so most insulated from supply factors. This serves as a reasonable proxy for inflationary expectations and “generalised” inflation in the economy — the only sort of inflation that a monetary authority can, and should, control. Core inflation has consistently stayed low this year, and was below five per cent in May. Clearly, therefore, high headline inflation, which the RBI cited as a reason for its refusal to act, was actually being driven by factors unrelated to pricing power — by real, supply considerations. Fixing those is not the province of monetary policy. Of course, core inflation cannot increase when India’s productive sectors are in crisis. Industry grew only 0.1 per cent in April, after a contraction of more than three per cent in March. Regardless of the problems with the index of industrial production (IIP) data series – which have been extensively discussed – it would be stretching credulity to suppose that these numbers do not, in fact, indicate a crisis. Of course, gross domestic product (GDP) growth has slowed considerably, going down to 5.3 per cent last quarter after four successive quarterly declines.
Above all, it is essential to get investment going again. India has a fortunate moment in which to do that. The depreciation of the rupee has given it a windfall gain in competitiveness. Meanwhile, capital is looking for a safe haven away from troubled western economies. India has to ensure that it is one of those safe havens — and an important step in doing that is to change the narrative of low returns. In its refusal to cut rates, the RBI might have adhered to a narrow, textbook idea of how monetary policy is made — but has not taken a hard enough look at the real situation in which it finds itself. It is not too late to correct this problem. Once the results of the Greece election are known, an out-of-turn cut that positively surprises sentiment should be considered.
