Change policy stance

Growth slowing, inflation moderating: RBI cannot just pause

As December 16 approaches, the date the Reserve Bank of India (RBI) is due to release its mid-quarterly review of monetary policy, there are two recent numbers that loom ever larger. The first is 6.9 per cent. That is the rate at which the Indian economy grew in the quarter between July and September, according to figures the Central Statistical Organisation released last week; the dip below seven per cent could have been expected, but still served as a stiff reminder. The second is eight per cent, the most recent year-on-year estimate from the commerce ministry of how much food prices have been growing. After a long stretch of double-digit numbers for food inflation leading into November, its sharp decline – a percentage point a week since Diwali – should perhaps cause the RBI to look anew at its resolutely hawkish policy stance.

The data are disputable, and rushed. Even so, some facts are unavoidable. First: growth is sputtering and slowing. On looking more closely at recent numbers, the picture just gets gloomier. The rate of increase in investment declined in the July-September quarter, indicating the danger of an imminent low-growth phase. Indeed, the eight infrastructure industries that drive growth – fertiliser, coal, electricity, petroleum refinery products, natural gas, crude oil, steel and cement – showed near-zero growth in the month of October. (In October 2010, they grew by 7.2 per cent.) The quarterly results for companies show that margins are squeezed across the board; and credit conditions appear to be tightening as well, with the off-take of non-food credit falling below the RBI’s own projections. (The RBI has promised to ensure that “there will be enough liquidity.”) The second undeniable fact is that food inflation appears to be easing. The major price pressures still visible are in vegetables and protein-rich foods like dairy products and eggs. As has been pointed out by many, including the prime minister’s office, a growing and aspirational India is likely to see an increasing demand for food items that were considered luxuries earlier. In short, this is not a phenomenon that can be easily managed from the demand side. Worldwide, commodity prices are also moderating — though the rupee’s weakness against the dollar means the effects of this moderation might not immediately be apparent domestically.

There is, thus, growing pressure on the RBI to pause its tightening of monetary policy. Rates have been raised 12 times since March 2010. The argument was made at the time that, given the weakness of monetary policy in the shallow financial system India still has, in order to arrest inflationary pressure, rates needed to be hiked sharply. Presumably, the effects of the tightening are visible now. Yet, by that same argument, a mere pause may not be enough: The RBI needs to cut rates. It has attempted to attack inflationary expectations, and has succeeded to the extent to which it was capable; rate hikes have now reached the limit of their usefulness. Nor is there any great virtue in doing nothing, or just tinkering with the cash reserve ratio. In India, even more than elsewhere, monetary policy acts with a lag. If it is the consensus of the RBI that inflation will subside to manageable levels by March or April next year, then the danger signs from the growth numbers indicate that the time to change its policy stance is now.