We expect interest rates to come off with growth slowing and inflation peaking off. We are relieved to see that the Reserve Bank of India’s (RBI’s) policy on Thursday would imply no further tightening monetary measures, and that future actions will be towards lowering rates.
In his guidance, Governor D Subbarao has happily dropped the phrase “…it is premature to begin reducing the policy rate…” from the January 24 policy. We did not expect a rate cut on Thursday as the central bank had just cut the cash reserve ratio last Friday. All the same, there is surely an iron-clad case to cut policy rates as soon as possible.
After all, high rates have pulled growth down to 6.1 per cent in the December quarter, far below the economy’s potential growth rate of about eight per cent. Second, a tight money policy has shrunk M3 growth to 13.5 per cent on February — also way below 17-18 per cent necessary for eight per cent growth. Core inflation has come off to sub-six per cent levels, with weaker demand killing corporate pricing power. Finally, high rates have pulled down loan growth to 15.6 per cent on February 24, again well below the 20 per cent levels needed to fund eight per cent growth.
We had strongly advocated monetary tightening in the past two years to rein in inflation. Yet, just as there is a time to tighten monetary policy, there is also a time to ease. Delaying monetary easing now will unnecessarily escalate growth risks without pulling down inflation.
It is true that inflation will likely rebound to 7.5 per cent levels for a few months in mid-2012 once the government increases oil, power and coal prices. At the same time, prolonging tightening is hardly likely to pull down global oil prices. In sum, the policy mind-set has to shift to protecting growth from fearing inflation.
Indranil Sengupta
Chief Economist-India,
Bank of America-Merrill Lynch