Now, the supply side

RBI does its part, government must move faster

On Tuesday, the Reserve Bank of India released its third-quarter review of monetary policy, and relieved the markets and many in industry by cutting the repo rate by 25 basis points to 7.75 per cent. In addition, the cash reserve ratio, or CRR, applicable to scheduled banks was cut by a similar margin to 4 per cent of their net demand and time liabilities – a step which will infuse an additional Rs 18,000 crore into the system.

The RBI’s moves follow what appeared to be a commitment at the time of its last announcement that the third quarter would see monetary policy actively change stance to prop up growth. Indeed, the review says on the subject of balancing growth and inflation: “It is critical now to arrest the loss of growth momentum without endangering external stability. The moderation in inflation conditions provides the opportunity for monetary policy to act in conjunction with fiscal and other measures to stem the growth risks.” This comes at a time when quarterly growth in gross domestic product has stagnated at between 5.5 and 5.3 per cent annualised for three quarters.

 

While fulfilling its promise and ensuring its credibility remains unimpeachable, the RBI has also gestured at the possibility of a further cut. It says that it expects inflation to be “range-bound around current levels” as the next financial year begins, creating some space for expansionary monetary policy. However, this suggestion is carefully qualified, first by saying that any such space is limited – so no deep cuts are likely – and second by pointing out that much depends on “the evolving growth-inflation dynamic and the management of risks from twin deficits”. In other words, the government cannot take its eye off the ball. Its mismanagement of the economy has contributed to a severe problem with the current account deficit as well as the fiscal deficit, and Mint Road has stressed again that it will not clean up the mess created by New Delhi. The RBI has also warned of the dangers of suppressed inflation, saying that the correction of administered fuel prices is “incomplete”. This is a reminder to the government that its fuel subsidy problem is not over.

The review says that “the key to stimulating growth is a vigorous and sustained revival in investment”. This is indisputably true. As the review points out, recent measures from the government have lifted market sentiment and might push investment, but that hasn’t kicked in yet. What is needed is real reform that unleashes productivity gains and removes supply-side constraints. After all, it is important to remember that, while consumer price inflation is so high, financial assets are unattractive to savers. Under those circumstances, deposit growth will be slow – and so banks will find it hard to increase lending regardless of whether monetary policy is loosened.