The central bank faces the daunting task of balancing growth and taming inflation, amid global turmoil.
The Reserve Bank of India has managed to temporarily prop up the economy’s flagging spirits by quite clearly stating that “the likelihood of a rate action in the December mid-quarter review is relatively low”. From the tone of the policy statement, it appears that Tuesday’s 25 basis points increase in repo rate could well be the last one in this rate cycle. This is the 13th hike since March 2010, which has seen the interest rate rise by a cumulative 525 basis points.
While all this may sound good, economists believe the central bank’s problem is far from over. In order to spur investments, the RBI must ensure a stable economic environment. The policy document spells out three broad contours of the monetary policy stance. The first one seeks to maintain an interest rate environment that contains inflation and anchors inflation expectations. Secondly, the policy should stimulate investment activity to support raising the trend growth, and finally, “manage liquidity to ensure that it remains in moderate deficit, consistent with effective monetary transmission”.
As far as moderation in inflation is concerned, the central bank may be right in its assessment to moderate over the next two months as commodity prices have come off in recent times. However, this benefit has been offset by the fall in rupee following a flight of capital. This has pushed up costs for companies importing raw materials. The bigger challenge will come with respect to spurring growth. While the global slowdown will help cool inflation, the turmoil in the world economy may also bring with itself some non-linear risks, if growth in Asian economies falls significantly below trend levels. However, like other Asian central banks, the RBI too will not rush to cut rates in anticipation of such a development, as any pre-emptive easing could result in overheating and asset price bubbles.
The sentiment may have turned, but all is still not well with India compared to other Asian economies. While currencies of other Asian countries recovered after a sharp fall, the rupee has not. If growth has to return to trend level of eight per cent and above, the government must do its part by providing a stable economic environment, conducive for investments. According to Nomura, “The government has not implemented any measures, despite increasing evidence of an economic slowdown. Given our estimate of a fiscal deficit of 5.5 per cent of GDP in FY12 (year ending March 2012) and India having the highest ratio of public debt to GDP in the region — of over 70 per cent, we see little room for a fiscal boost.” All eyes are now on the new manufacturing policy.