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RBI is justified in holding back on repo rate

The Reserve Bank of India (RBI) has painted the picture of an economy where inflation is rising – retail inflation has gone up by around 2 percentage points since the Monetary Policy Committee’s last meeting – while growth is decelerating and is expected to slow down further. The combination of these two factors justify the RBI’s decision to hold back reduction in the repurchase rate – the rate at which the central bank infuses liquidity in the banking system – in the fourth bi-monthly monetary policy review on Wednesday. The RBI has slashed its estimate of the full year (2017-18) growth rate of the gross value added to 6.7 per cent, as against 7.3 per cent earlier, and has revised the consumer price index (CPI)-based inflation estimate from 4-4.5 per cent to 4.2-4.6 per cent for the second half of the financial year.  

The latest monetary policy review came against the backdrop of hopes expressed by many in the government and industry that the RBI would do its bit to boost economic growth, which has now decelerated for the last five quarters. Of particular worry is the 5.7 per cent growth of the gross domestic product in the first quarter of the current financial year. This means that when substantial parts of the global economy, both in the developed world as well as the emerging economies, are registering economic expansion, India’s economy seems to be slowing down. The US and the Euro Zone have expanded, so has the Japanese economy. China has received a boost from robust domestic demand while Brazil and Russia, too, have grown. The outlook for world trade in 2017 is also looking up, but India seems set to miss out on the global party in a stark turnaround from being the “only bright spot” in the global economy not so long ago.

To be sure, the RBI is in a quandary. It is not clear whether the ongoing slowdown is a result of transient factors – be it demonetisation or the disruption due to the introduction of goods and services tax – or a manifestation of more long-term structural hurdles such as a banking system severely hampered by non-performing assets and an over-leveraged corporate sector. The RBI has reiterated the need to revive sluggish private sector investment in order to provide a fillip to the economy as well as improve demand for overall credit. Also, in order to achieve the 6.7 per cent GVA growth for the while year, the RBI expects the GVA to grow by 6.4 per cent in the second quarter, 7.1 per cent in the third quarter and 7.7 per cent in the fourth. While it is true that some sectors of the economy have indeed seen an uptick in demand in recent months, these projections might look too ambitious as of now. An optimistic scenario is that the festive spirit will lead to a spike in consumption, helped by the Pay Commission’s award, even as the teething troubles of GST implementation are taken care of. 

However, with CPI inflation, excluding food and fuel, jumping sharply in July and August, there is always a chance that such growth may accompany a higher cost of living, which is always a tricky issue, especially when governments enter the last lap of their political terms. The RBI has reiterated that the government should focus on further reforms while improving the quality of its own spending and avoiding fiscal slippages. Over to the government.