In its third quarter review of monetary policy, released on Tuesday, the Reserve Bank of India kept the policy rate — the repo rate for banks — constant at 8.5 per cent, while cutting the cash reserve ratio (CRR) by 50 basis points, from 6.0 per cent to 5.5 per cent of their net demand and time liabilities. The RBI has argued that the latter action can be taken to ease liquidity without diluting its current policy stance. That stance, essentially, seems to be to wait and watch: while the review acknowledges that India’s growth has faltered, and indeed revises the estimate for 2011-12 GDP growth downward sharply to 7 per cent from 7.6 per cent, the RBI appears not to believe that its interest rate policy can be used to counteract this deceleration. It prefers instead to wait to see hard evidence of “signs of sustainable moderation in inflation” before altering the policy rate. This is a conservative position.
The RBI raised the policy rates 13 times in the months leading up to October 2011. As it itself acknowledges, a high interest-rate regime is one of the major restrictions on the revival of GDP growth. The central bank says that it must maintain policy rates in order to anchor inflation expectations. Yet its own statement acknowledges that a moderation in inflation expectations is visible in the pick-up of demand for government securities visible in the slackening of yields since the last hike in mid-October. There is little evidence in this statement as to whether the RBI has asked itself whether its past actions have succeeded in already anchoring expectations. Nor is there any acknowledgement of the lag in monetary policy transmission, which it has previously argued — when raising rates — is three to six months. The RBI felt no need to alter its belief that inflation would decline to 7 per cent by March. Why, then, if it is setting policy for the period after that, has it failed to alter its stance on rates?
Some of the problem appears to be that the RBI feels that growth is only the government’s problem. While the Centre’s paralysis continues to be a major reason why investment has slowed down alarmingly, a change in the policy stance should not always be made contingent on action from New Delhi. Yet that is precisely what the RBI’s guidance says — that “the timing and magnitude of future rate actions is contingent on... policy and administrative actions, which induce investment that will help alleviate supply constraints in food and infrastructure”. The guidance also argues that fiscal consolidation in the upcoming Budget is necessary in order for it to have the space to cut rates. While the Budget must indeed return India to a fiscally sustainable path, and New Delhi’s unwillingness to push forward far-seeing reform in food and infrastructure must end, the RBI cannot just limply lob the ball back to the government.