Explaining the reasons behind today’s 25-basis point cuts in the repo rate and CRR (cash reserve ratio), RBI Governor D Subbarao said for future rate cuts, inflation and the current account deficit would have to fall to levels lower than projected by the central bank. Excerpts from his post-monetary policy interaction with the media:
Policy rationale
The decision was based on three considerations. One was inflation moderation — both headline and core inflation — and the momentum of inflation. We have had deceleration of growth, not just of investment but also of net exports. The third consideration was liquidity and that was quite tight for the past few months. Because of CRR cuts in September and October, we pumped in Rs 35,000 crore and with today’s CRR cut, another Rs 18,000 crore would be pumped in. We did OMOs (open market operations) of Rs 47,000 crore in November and December. So, it adds to Rs 1 lakh crore. In January, the average bank borrowing from RBI was Rs 91,000 crore.
Growth
On the domestic economic side, growth has decelerated. First quarter growth was 5.5 per cent and in the second quarter, it was 5.3 per cent. Taking into account the developments since the last quarterly policy review, we revised our growth projections for the full year downward — from 5.8 to 5.5 per cent.
In the first half of the year, growth was 5.4 per cent. So, to achieve 5.5 per cent for the full year, in the second half, growth has to be 5.6 per cent. We think growth has bottomed out.(PUSH FOR GROWTH)
Risks to growth
We indicated five risk factors. First is the twin-deficit risk arising from high CAD (current account deficit) and large fiscal deficit. The second risk factor stems from the global outlook — the global risk perception and its implications regarding financing the CAD. The third relates to the inflation outlook. Sustained reduction in inflation will have to come from vigorous supply response. The fourth is on investment. This is very important, as it is key to stimulating growth. Achieving this would depend on a number of factors like bridging infrastructure gaps and the resolute pursuit of structural reforms.
Finally, we also mentioned banks’ asset quality. RBI is concerned about the high level of NPAs (non-performing assets). But we are also concerned that high NPA levels should not reduce the flow of credit into productive sectors of the economy.
Inflation risks
Food inflation, both in WPI (Wholesale Price Index) and CPI (Consumer Price Index), has been very high, and that could put upward pressure on inflation expectations. The second risk comes from monthly diesel price increases, which are good for long-term inflation management, but would put pressure on inflation in the short term.
The third is global crude prices. These have plateaued in the last couple of months; the fact that they plateaued means there will be some upward pressure. The fourth risk factor is suppressed inflation. Last year, coal prices were adjusted in January. So, that gives a benign base effect on the last quarter of the financial year. We expect coal prices would be adjusted later this calendar year; there will be a consequent adjustment in electricity prices. So, some suppressed inflation will come out.
Finally, there is pressure from wages, as rural wages continue to go up. The concern is the increase in wages has not been accompanied by an increase in productivity.
Current account deficit
By far, the biggest risk for inflation and for macroeconomic management is CAD; not just high CAD but high CAD in the context of slowing growth and high fiscal deficit. For the first half, CAD was 4.7 per cent. Third quarter trade numbers are quite disappointing and CAD for the third quarter will also be high. This is a problem, as it has implications for financing the CAD, implications for exchange rate stability, especially because it is happening in the context of slowing growth. Our ability to attract capital flows would be affected if growth slows.
There is also another concern about CAD, something not often discussed — the quality of CAD. If we had high CAD because we were importing capital goods, that would be okay. If CAD is high because we are importing a lot of diesel when demand is not price-elastic and if we are importing a lot of gold, that is a concern.
Stance
If inflation and CAD moderate further (by further, we mean more than expected…in the fourth quarter, CAD may be less than in the third quarter, but it has to be significantly less), there will be more room for monetary policy easing. But if they go along the currently expected lines, the scope for monetary policy easing is quite limited.
