The Reserve Bank of India in its monetary policy review on June 17 kept the repo rate and the cash reserve ratio unchanged at 7.25 per cent and 4 per cent, respectively.
This policy stance has been based on the evolving growth-inflation dynamics and recent developments in the external sector.
Notwithstanding the favourable change in the Wholesale Price Index and the possibility of achieving a reduction in the current account deficit (CAD), thanks to curbs on gold imports, the Reserve Bank opted to keep the rates unchanged. This largely because of its concern about persisting retail inflation, particularly food inflation, and the continued depreciation of the rupee which could increase the CAD.
This is made clear in its guidance note, which states that the monetary policy stance will be determined by growth and inflation trajectories, and the balance of payments situation.
It is only a durable receding of inflation that will allow monetary policy to continue to address risks to growth, the note adds.
Inflation concern
The Reserve Bank’s worry on inflation expectations is justified as the Government has plans to increase gas and coal prices in the near term in addition to the price hikes now being effected in respect of oil on a monthly basis.
Further, the sharp depreciation of the rupee has made imports costlier and pricing of exportable items uncompetitive to take advantage of the depressed value of the rupee.
The overall cost of production and cost of funds in the economy have not been contained because of multiple reasons, such as cost overruns due to project delays caused by non-availability of adequate land, power and other essential infrastructure, and banks’ inability to provide need-based credit at reasonable rates. The mobilisation of deposits without compensating the depositors with a real rate of return has led to the diversion of savings to unproductive investments.
The monsoon has just begun and how far it can help boost agricultural production cannot be fully factored in at this stage in framing the monetary policy.
Food inflation is already high and the current politico-economic atmosphere is also not too conducive to expect highly favourable policy initiatives for both agriculture and industry.
If the monsoon is favourable, the risk of food inflation gets mitigated to some extent provided the storage, distribution and marketing of the products are taken care. This calls for strong administrative measures.
The external sector is also unpredictable as economic recovery, except to some extent in the US, is still in a fluid stage. The Federal Reserve move to taper off quantitative easing can drastically reduce the flow of funds to emerging economies, including India, and make exchange rate movements more volatile.
The trade deficit continues to increase and has touched a seven-month high of around $20 billion despite the series of measures introduced to contain gold imports. The inflows through FDI and FIIs depend on the policies of the Government which, as of now, are not very encouraging.
Expectation of inflows through other channels, such as commercial borrowings and remittances from abroad by offering attractive rates of interest, can only add to the inflation and cost of funds in the economy.
Prudence demands that the RBI does not overlook these ground realities and go in for a reduction in policy rates to suit the sentiments of the market or expectations of some segments in the economy. The RBI’s concerns can be well gauged from the policy statement, where it categorically observed that “while several measures have been taken to contain the current account deficit, there is an urgent need to be vigilant about the global uncertainty, the rapid shift in risk perceptions and its impact on capital flows.”
Capital flows
Both outflows and inflows of foreign capital, which have a direct bearing on inflation and exchange rate, have to be closely monitored both by the Government and the Reserve Bank in the overall interests of the economy, and this is what has been explicitly projected through this policy review.
By way of abundant caution, the Reserve Bank has clearly stated that the continuing weakness in manufacturing activity needs to be urgently reversed and the key to reinvigorating growth is accelerating investment by creating a conducive environment for private investment, improving project clearance and leveraging on the crowding in role of public investments.
The Reserve Bank has limited role in these areas and the initiative and action have to come from the Government.
The Reserve Bank’s approach is balanced in the present, fast-deteriorating economic situation and the policy highlights the challenges the economy faces both from the domestic and external fronts.
This calls for highly professional, meaningful and result-oriented solutions.
Earlier, the Government joins hands with the Reserve Bank and takes appropriate administrative and economic policy initiatives the faster the economy will get back on the growth track without inflationary pressures. The masses would be the beneficiary.
(The author is a Bangalore-based financial consultant. The views are personal.)