RBI runs out of room

The ball, once again, is in New Delhi's court

The Reserve Bank of India (RBI) in its mid-quarter review of monetary policy has done largely as expected and cut the headline policy rate - the repo rate - by 25 basis points to 7.5 per cent. This takes the total monetary easing from India's central bank since the beginning of last calendar year, when the RBI had announced it was shifting to a somewhat more accommodative monetary policy stance, to 100 basis points - after a cut of 50 basis points and two cuts of 25 basis points each. In the same period, of course, growth has collapsed to 4.5 per cent year on year in the last released quarter, losing almost half its momentum. But, as the RBI has been quick to point out, consumer price inflation remains high, which means, by the central bank's logic, that monetary stimulus cannot be as aggressive as the growth slowdown would warrant.

That being said, the review document makes for sobering reading. As it points out, global economic activity has weakened - making it less likely, for example, that the market for Indian exports will pick up quickly, allowing the current account deficit to set itself to rights speedily. In addition, services sector growth - which had served to minimise the effect on growth of the crisis in Indian manufacturing - has fallen off sharply. The RBI notes, but does not fully acknowledge, the fact that "core" inflation - inflation in non-food manufactured products - has moderated considerably, and that the sole driver of inflation now is food prices, which are unlikely to be contained by monetary tightness. The RBI has a warning for the government against raising minimum support prices further, but whether the government will heed it is another matter altogether.

The impression the review gives is that the RBI felt it was committed to making a cut in the repo rate in order to reward the government for its supposed efforts at fiscal consolidation in the last Budget, but it was loath to do so - and definitely does not intend to ease monetary policy further in the absence of noticeable changes to the supply side. While the usual exhortations to clear bottlenecks in production and to improve the governance surrounding project implementation are dutifully made - and should be followed - it is not clear whether those will moderate food inflation, which requires quite a different sort of supply-side intervention. The RBI, thus, concludes its guidance for the future by saying that although its policy stance remains committed to growth, it feels it doesn't have much headroom for further cuts.

The government has clearly pushed the RBI to the limits of what, right or wrong, it feels it can do. The time has come, therefore, for the question of Indian exports and of food production to be central to New Delhi's agenda. Improving the competitiveness of Indian exports will require manufacturing to be given a big boost through clearances and reform; without that, macro-economic conditions will remain unstable. And long-overdue reform of India's agricultural sector must be pursued on a war footing, or else food inflation will remain at double-digit levels and the RBI will refuse to cut interest rates further to spur investment and growth.