Time for another cut

The risks associated with maintaining the status quo far outweigh those associated with a cut in rates and CRR

The Reserve Bank of India (RBI) will reveal its monetary and credit policy stance for the year ahead in its scheduled quarterly announcement on April 21. Looking back over the past six months, the RBI has certainly been very active in both lowering its policy rates and infusing more liquidity through a reduction in the cash reserve ratio. The repo rate, at which the RBI lends money to the banking system, has been brought down from 9 per cent to 5 per cent. The reverse repo rate, which the RBI pays banks for deposits placed with it, has been reduced from 6 per cent to 3.5 per cent. The cash reserve ratio (CRR) has been reduced from 9 per cent to 5 per cent. These are not small changes by any means. The question now is: do the macro-economic conditions warrant a further change next Tuesday?

The answer is a categorical “yes”. Since January, the main high-frequency indicators, the Index of Industrial Production and the Wholesale Price Index, suggest that both industrial growth and the inflation rate are near zero. Under any circumstances, this makes a case for an expansionary monetary policy, assuming there is room for it. There is no problem on that front. Both the US Federal Reserve and the Bank of Japan have already taken their benchmark rates to zero; the RBI's repo rate is still 5 per cent. Even if there is understandable reluctance to take it to zero, it can surely be reduced by a substantial amount. Similarly, the CRR was intended to be fixed at 3 per cent, from where it was moved up to deal with the influx of funds from abroad. In today's circumstances, there is no reason for it being above its permanent level. Going beyond the visible indicators, the RBI has a responsibility to reinforce what seem to be some very early signs of stabilisation. Automobile and consumer durable sales are displaying mild upticks. Bank credit is emerging from its sluggish state and businesses are finding it a little easier to finance inventories. Spreads between corporate bonds and government securities are narrowing, again suggesting that companies are finding it a little easier to get funds. On the other side of the coin, as far as interest rates are concerned, the higher than anticipated demand for funds by the government has pushed them up to levels that are somewhat inconsistent with the growth and inflation situation. The RBI can certainly consider evening out the balance.

The main argument against any rate or CRR cut next week is that the system is already awash in liquidity. If money is not moving at a desirable pace into the real economy, further measures are redundant and the RBI would do better to wait until that movement is visible. The counter to that is there are early signs of movement, which must be reinforced by pushing both the cost of funds and the benefits of parking excess liquidity with the RBI as low as possible. This will be complemented by the recent reductions in deposit rates by banks. Further, with the repo rate still at 5 per cent, there is enough in reserve to support an acceleration in credit flows. The bottom line is that the risks associated with maintaining the status quo far outweigh those associated with a cut in rates and the CRR.