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Signalling confusion? When they don't act in concert …
- The Reserve Bank of India (RBI) may have disappointed many by keeping the key interest rates unchanged. But it let the cat out of the bag when it sort of set the term for dropping interest rates.
- The only change in monetary policy instruments — a cut in the Cash Reserve Ratio (CRR) by 0.50 percentage point to 5.5 per cent — was largely expected.
- Notwithstanding its open market operations to inject over Rs.70,000 crore into the system, the RBI found the liquidity conditions “tight beyond its comfort zone.”
- According to the RBI, the CRR is a policy instrument with liquidity dimension. Its reduction will bring down the cost of money for banks and have a bearing on their ability to lend at lower rates.
- The RBI has cited three well known reasons in support of its latest stance.
- (a) While some slowdown in the growth of demand was expected as a result of earlier monetary policy moves to control inflation, at this juncture risks to growth have increased.
- (b) The fall in WPI inflation is due to a sharp decline in the prices of seasonal vegetables. However, protein-based food items and non-manufactured food inflation remain high. Further, there are many upside risks to inflation. Global petroleum prices remain high. The lingering effect of recent rupee depreciation continues and there is a significant slippage in the fiscal deficit.
- (c) Liquidity conditions have remained tight beyond the comfort zone of the RBI despite massive infusions through open market operations.
- A number of infrastructure sectors, especially power, are mired in deep financial troubles.
- Many times in the past too, risk aversion on the part of banks has been cited to explain the fall in lending. Given the dominance of government banks, it is of utmost importance to put in place a system of accountability, which will not penalise risk-taking.
- It advised the government to “exploit the forthcoming Union Budget” to “begin this process in a credible and sustainable way.”
- Not surprisingly, the RBI asserted that the timing and magnitude of future rate actions hinged on a number of factors. In this context, it pointed to the ‘significant threat' posed by fiscal slippages to inflation management and macro-economic stability.
- The below-projected 15.7 per cent growth in non-food credit, according to the RBI, was the consequence of a significant expansion in net bank credit to the government, which had grown to 24.4 per cent compared with 17.3 per cent last year.
- In the light of increased government borrowing, the apex bank is expecting the gross fiscal deficit for 2011-12 to overshoot the budget estimate substantially.
- “This could potentially crowd out credit to the private sector,” the RBI said. This surely will spell consequential risk to the economy by adding up to the inflationary pressures.
- “It will be prudent to fully de-regulate the diesel prices to contain both aggregate demand and trade deficit,” it said.
- The signal is crystal clear. Monetary measures alone won't suffice. The government must do its bit.
- The onus is now on the fiscal managers to gather courage and move decisively. Until that happens, it is hard to expect monetary actions to have the intended effect on the economy.
