Bloomberg consensus expectations pointed to no change in monetary policy setting in India, ahead of the meeting of the Reserve Bank of India (RBI) held on January 24th. However, RBI left interest rates unchanged but reduced the cash reserve ratio (CRR) to 5.5% from 6.0% effective from January 28th. Many feel that the RBI had sent confusing signals again. Some of the analysis of the monetary policy action of the RBI also reflect that confusion.
RBI was expected to engage in Open Market Operations and tweak the Statutory Liquidity Ratio if it wanted to address liquidity. A cut in CRR is now interpreted to presage aggressive rate cuts. I wonder if it is the case. A 50-basis point cut in CRR could be a substitute for aggressive rate reductions.
Elsewhere, RBI lowered its growth estimate down to 7.0% from 7.6% for the current financial year ending March 2012. It expects growth in 2012-13 to be slightly better (we are not so sure). It left its forecast for the wholesale price index based inflation rate unchanged at 7% for 2011-12 and said that the forecast for inflation in 2012-13 is subject to considerable uncertainties. In other words, the central bank is not confident – and rightly so – that inflation would decline materially. Core inflation is not only higher now than when RBI began hiking rates but is showing no signs of topping out, yet.
Both in the press statement accompanying the policy decision and in its review of the macro-economic and monetary developments in the third quarter (Oct. – Dec. 2011), the central bank minced no words in holding profligate government spending responsible for higher inflation, for tight liquidity and for lower growth (crowding out effect on private sector capital formation). RBI expects the central government budget deficit for 2011-12 to be substantially higher than original estimates.
While State governments have made progress on consolidating their finances, their contingent liabilities arising from the guarantees they have extended on bank loans to electric power distribution companies are considerable and could nullify the progress on budget consolidation, if the guarantees are invoked.
India’s import of crude oil is rising and along with it, the subsidies extended by the government on fuel prices rise too. India’s energy policy encourages private means of transport as opposed to more efficient public transportation, environmental pollution and compounds its fiscal woes. RBI is correctly realistic about the outlook for the price of crude oil in the months ahead, in the light of aggressive monetary easing in the West and potential supply disruptions if the geopolitical environment worsens.
In sum, the picture one gets is that – going by the stated intent of the central bank – rate cuts would be slow and gradual. Rate cuts in the year 2012-13 might amount to 50-100 basis points but aggressive rate cuts are, by no means, assured. Much depends on the central government’s intent and delivery on budget consolidation. Both are suspect, to say the least.
It is hard to divine the intent and the ability of the central bank to deliver on its intent, based on its statements. That is no criticism. For the most part, RBI is making up policy on the fly, I guess.That perhaps is the only way to make policy under the circumstances – if it is buffeted by domestic growth and inflation challenges, global inflation pressures and political pressures from the government.
For what it is worth, I am not betting on aggressive rate cuts from RBI in 2012-13. May be, I am taking the Reserve Bank of India’s tough-talk on fiscal deficits and uncertain inflation outlook more seriously than it deserves to be.