The world is not in a happy place, least of all India, the rush of liquidity (into stock markets) notwithstanding. All that the recent measures, global and domestic, have done is to improve the negative sentiment. The recent measures announced by the advanced economies (read massive liquidity injections by European Central Bank and the US Federal Reserve) have brought about a modicum of stability to the world’s financial markets, but the structural issues continue. There is no clarity on any roadmap that will return the advanced economies back to the growth path. This will have implications for emerging economies like India, where growth has been slowing since last year.
So the Reserve Bank of India has added to the feel good by shifting its stance to support growth, but this shift has not resulted in any repo rate cut. Thanks to slowing growth and sovereign risks emanating from advanced economies, central banks are faced with a difficult task of balancing slowing growth, fiscal consolidation and growth stimulus. India has been paying the price of a protracted fiscal stimulus unleashed after the Lehman crisis in 2008.
The other major message is that inflation is not near ebbing. In the short term, prices are expected to spike before they start cooling early next year. The central bank, thus, has decided to release liquidity to the tune of Rs 17,500 crore into the system through a cash reserve ratio (CRR) cut of 25 basis points to 4.25 per cent. Nomura’s India economist Sonal Varma says: “Given political pressure on the RBI to cut rates at this meeting, we see today’s decision as prudent and fortifying the RBI’s inflation fighting credibility. The RBI revised down its GDP growth projection to 5.8 per cent y-o-y in FY13 from 6.5 per cent (Nomura: 5.8 per cent) and revised up its inflation projection to 7.5 per cent y-o-y by March 2013 from an earlier 7 per cent (Nomura: 7.5 per cent).”
Despite all the challenges and risks to inflation, the central bank’s guidance says: “…while risks to this trajectory remain, the baseline scenario suggests a reasonable likelihood of further policy easing in the fourth quarter of 2012-13.”
In order to support growth the central bank has decided to reduce the CRR of scheduled banks by 25 basis points from 4.5 per cent to 4.25 per cent of their net demand and time liabilities, effective the fortnight beginning November 3, 2012.
RBI Governor D Subbarao said: “The reduction in the CRR is intended to pre-empt a prospective tightening of liquidity conditions, thereby keeping liquidity comfortable to support growth. It anticipates the projected inflation trajectory which indicates a rise in inflation before easing in the last quarter. While risks to this trajectory remain, the baseline scenario suggests a reasonable likelihood of further policy easing in the fourth quarter of 2012-13. The above policy guidance will, however, be conditioned by the evolving growth-inflation dynamic.”
By keeping the system oiled with enough liquidity, the central bank is trying to ease turnaround credit conditions in productive sectors of the economy. It will reinforce growth stimulus to the economy once the battle against inflation is seemingly won and it is able to “anchor medium term inflation expectations on the basis of a credible commitment to low and stable inflation.”