The Reserve Bank of India (RBI) continues to wait for inflation to weaken before cutting policy rates further. Not that a 25-basis-point reduction in the rate at which the central bank lends short-term money to banks would galvanise the somnolent credit market or revive comatose investment. What it would do is to signal to economic agents that the central bank is capable of intervening to make appropriate trade-offs among interest rates, inflation and the exchange rate, even if it cannot simultaneously control all three.
The overvalued rupee hurts exporters and contributes to both widening of the current account deficit and resort by the government of regressive trade policy to contain imports, lowering India’s leverage in global trade negotiations.
The Monetary Policy Committee’s legal mandate is to keep inflation in a 2-6 per cent band, not always keep it close to 4 per cent. It is possible for the RBI to allow for a mild rise in inflation, while reducing the incentive for foreign investors to borrow cheap abroad and dump that money in India’s debt market to earn easy profits, raising liquidity in the system so as to depress money market rates out of the desired policy rate corridor and force the central bank to absorb liquidity, all the while spreading despair among exporters.
The RBI is right to worry about the states using up their fiscal space to waive farm loans, take on the losses of bankrupt power utilities and give their employees handsome salary hikes. It is also right to worry over hardening non-food prices, in the background of a fall in kharif prospects and the likelihood of imported inflation via hardening oil prices.
It is right to call upon the government to step up investment. Reducing the statutory liquidity ratio to 19.5 per cent and mandating a Legal Entity Identifier for borrowers are welcome steps, too.