The RBI has done well in not overlooking the ground realities and
going in for a reduction in policy rates to suit the sentiments of the
market or expectations of some segments in the economy.
June 23, 2013:
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.
Dr.T.V.Gopalakrishnan
(The author is a Bangalore-based financial consultant. The views are personal.)
(This article was published on June 23, 2013)
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