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Decoding Subbarao’s signals

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When Reserve Bank of India (RBI) governor Duvvuri Subbarao announced last week that the central bank was cutting its policy interest rate for the third time this year, he also made a statement that may well have been directed as much to watchers of the Indian economy as to its managers. His message to the government, originally coded in technocratic diplomacy: It’s time for you to do your share in reviving growth.

Financial markets had widely anticipated the RBI would cut its repo rate by 25 basis points (bps). However, they also expected its policy guidance to adopt a less hawkish tone than in the two prior cuts. After all, inflation had continued to ease and the economy still needs all the support it can get to come back on the growth path. Instead, Subbarao was categorical in saying that the “growth-inflation dynamic yields little space for further monetary easing.”

The statement stood out all the more because it came around the same time that the world’s largest central banks made their easing biases more obvious: the European Central Bank cut its policy rate; the Bank of Japan reaffirmed its commitment to monetary expansion; and the Federal Reserve stood ready to adjust its bond-buying program as conditions demanded. In short, global central banks remain willing to loosen the flow of money to stimulate growth.

So why the hawkish talk from Subbarao? We suspect several factors were at work. The first was pretty clear: the RBI remains mindful of India’s current-account deficit. While prices of gold and crude oil have declined significantly in the last few months – helping rein in the country’s expenditure for its two most crucial imports – the RBI acknowledged that “it cannot afford to lower its guard” against the possibility of an upward price pressure.

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