The wait for the rate cut

December 24, 2012

(Any opinions expressed here are those of the author, and not those of Thomson Reuters)

At its mid-quarter review on Jan. 18, the Reserve Bank of India (RBI) did not cut the repo rate and also left the CRR unchanged. But it raised hopes that policy easing can follow in the fourth quarter.

The firm message the RBI has been sending all along is that it is entrusted with the singular objective of “maintaining price stability and ensuring adequate flow of credit to productive sectors”. Surely, price stability does not necessarily mean static prices but allows for a gentle rise not exceeding 6 per cent. This level of inflation the consumer can take in his stride and is really good for investment because it reduces the real rate of interest.

That has been so with most other central banks though their tolerance limit for inflation is generally low. But since the financial crisis of 2008 there has been a radical transformation in outlook. It is no longer inflation but growth that is the target.

U.S. Federal Reserve Chairman Ben Bernanke recently redefined the monetary policy objectives. The interest rate, he said, will remain at zero until the level of unemployment comes down to 6.5 per cent. Presently it is 7.7 per cent. It has also been indicated that the rate may not be increased even after unemployment drops to the target level. That is a necessary but not a sufficient condition for tightening the policy. The Fed expects that it would not be before 2015 that unemployment will be less than the target level. Hence it will keep the rate in check with quantitative easing (QE).

The same anxiety is revealed by many other central banks even from emerging market economies. The People’s Bank of China cut interest rate twice in 2012 because the rate of growth had dropped to 8.1 per cent. The Brazilian central bank has cut interest rate 10 times since July 2011 to a record low to revive economic growth.

The new mantra obviously is growth whether it is a developed country like the U.S. or emerging economies like China and Brazil. It is much easier to curb growth than to revive it. Hence the priority should be to prevent growth from falling. The RBI tried exactly its reverse. It aimed to bring down growth ‘temporarily’ in order to check inflation. The result? Growth dropped but inflation did not.

It is time that the RBI re-looks at its monetary policy objectives. If at all there is choice between reasonable  inflation and possible growth it is the latter that should have priority. For, growth is not for its own sake. It means employment, it means more money with Government for poverty alleviation, it means lower budget deficit and consequently lower inflation.

The RBI has held out hope that the repo rate will be revisited in the last quarter. But minor changes don’t make an impact. What are called for are cuts in quick succession, as the RBI did in 2008, when the economy was in a similar chaotic state.


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So much on RBI’s stance on interest rate, as if the entire economy is getting effected by the interest rate alone. RBI’s tools are limited to monetary (money) policy and their stance is carefully pro-active so far to the supply component of money, call it through interest rate or mild timely intervention in forex. The supply of goods, production and employment side should come through other Governmental actions, which the Govt already started demonstrating in making some reforms, though more popular reforms. Though it takes time to perceive the efficacy of all the reforms that are in the queue, the boldness with which the progress is handled is conspicuous and pro-active. It naturally takes time to see the resultant direction of the existing monetary and fiscal policies. It is also worth noticing that the corporate performance is positive so far as per the reports. Hence, the no hurry stance of RBI is quite understandable. At the same time, it is doubtful to adapt the priorities spelt out by other countries, as applicable to us. It is also doubtful, that Brazil and China also switched over to low interest regime only to give top priority to employment. Their reasons may or may not be treated as universally applicable. Anyways, it is not clear to me which are all the growth and employment oriented projects that are held up or getting delayed due to RBI’s interest rate stance. As per the news items, corporate performance is seen better, mergers are going on, new projects are up in India and abroad and the stock market went up so high. Of course, it also gets overly volatile on the critical days of any policy announcement. But, …..but, still lot of demand is seen being made on RBI that interest rate aspect, by industry leaders including bankers. It is really confusing to the common man as to some negativity is set in into the economy. It is high time that the monetary and fiscal managers make the situation clear jointly to avoid repeated references.

Posted by L.S.Mullapudi | Report as abusive

In my view, it is high time that Banks put thier house of lending practices and , recovery processes in particular, to really good order to ensure that good money (that may be released) does not chase bad loans.
The practice of dealing with NPAs require far more transpereancy that the current euphemistic process of restructuring the out-of-tune accounts.

Posted by Ashok_Vaishnav | Report as abusive