Lacking conviction

The Reserve Bank’s decision to cut the repo rate by 25 basis points from 7.75 per cent to 7.5 per cent was just a blip, and is more a concession to sentiment than an act of conviction. There was pressure on the apex bank from various quarters, including from the government and public sector and private sector lenders, to ease the liquidity situation through monetary measures.

Though the RBI has not been known to respond to such pressures, as its record of a conservative and ultra-cautious monetary policy through many quarters has shown, it has made a gesture this time. The bank had make a 25 basis point reduction in the repo rate in the last quarter also after a long period of hiking interest rates or holding them stable, but does not seem to be convinced of the effectiveness of the policy measure.

The apex bank’s observations in the mid-quarter economic review make this very clear. It has noted that economic activity has slowed down and GDP growth at 4.5 per cent in the third quarter of the current fiscal is the lowest in the last 15 quarters. Investment has fallen and industry’s competitiveness has suffered. But while accepting that high interest rates are a dampener on investment, it has not accepted that a low interest regime will alone boost it. Inflation, especially food inflation, remains at an unacceptably high level. In the trade-off between growth and inflation, the RBI has always given importance to containing inflation, and the latest policy stance is also proof of that. It has also almost ruled out any further easing of the rates in the near future.

It has again rightly shifted the responsibility to the government by reminding it of its critical role in fiscal consolidation, easing of supply bottlenecks and improving governance. The current account deficit is still high and inflationary expectations arising from fuel price hikes and increasing support prices for agricultural produce will remain strong. The divergence between core inflation, which seems to be easing, and the consumer price inflation, which is worsening, was in fact expected to give room for the RBI to take a more liberal stance. It is for the government to take steps to counter the economic slowdown and convince the RBI of the need for monetary measures to ease the liquidity situation.