When will the repo rate be reduced?

November 1, 2012

(The views expressed in this column are the author’s own and do not represent those of Reuters)

In his policy review on Oct. 30, Reserve Bank of India (RBI) Governor D. Subbarao stuck to his position that money cannot be made cheap when commodities are becoming expensive.

So, the repo rate has to stay where it is. When that cannot change, the reverse repo rate and the marginal standing facility rate have to stay put. That is what the RBI has been doing for six months now. The last time the repo rate was reduced was in April.

But the RBI has taken care to lubricate the wheels of the economy. There was liquidity deficit brought about by the wedge between deposit and credit growth of banks. Deposits have been increasing at 14 percent (y-o-y) while credit expansion was at 16 percent. To bridge the liquidity gap, Subbarao reduced CRR from 4.5 to 4.25 percent. That would put an additional 175 billion rupees of primary liquidity into the banking system.

But liquidity is not the real issue. It is the rate of interest which is central to policy change since it is holding up investment.

Finance Minister P. Chidambaram had timed his press conference on fiscal consolidation a day before the RBI quarterly review to convey that the government was committed to the reduction of fiscal deficit and the RBI could go in for monetary loosening. Subbarao accepted it as a positive factor but did not budge, suspecting that subsidy reduction may be difficult politically. That left the finance minister utterly disappointed.

Even if the government had reduced subsidies drastically, Subbarao would not have changed his mind. That is because what is good for fiscal consolidation is bad for inflation. As the governor mentioned, with subsidies, inflation had remained suppressed. Reduce subsidies and inflation will flare up. Undoubtedly, it would.

Last September, wholesale price index (WPI) inflation jumped because the government reduced subsidy on diesel while state governments did so on electricity. The governor wants it both ways: reduce subsidies but do not increase prices. Difficult?

The next three months will see no end to inflation. The rupee may depreciate and consequently, increase the prices of imported products. And import prices count. Nearly three-fourths of our petroleum products are imported. There are also other critical imports which are important components of the WPI basket.

So, the RBI governor is steadfast. Inflation, whatever its cause or source, means a rise in prices and therefore money cannot be made cheap. If commodities have become costly, money also must command a higher price. Hence, the repo must stay where it is.

But all is not lost. The RBI assessment is that inflation will rule high until December and ease thereafter. If governments, investors and consumers have a little more patience and wait until March next year for inflation to come down, the RBI would willingly reduce the repo and reverse repo rates. If, however, inflation continues the governor would not mind if growth drops further.

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