The annual statement of monetary policy for 2013-14, released by the Reserve Bank of India (RBI) on Friday, took steps that most observers had expected, even though many had hoped for more. By reducing the repo rate by 25 basis points, to 7.25 per cent, it continued with the sequence of reductions it had first initiated in April 2012 but then suspended until January 2013. A relatively rapid decline in core inflation, which is clearly a concomitant of the growth slowdown, provides the primary justification for an easier monetary stance. However, the persistence of high headline inflation, particularly as measured by the consumer price index, on which it still clocks in excess of 10 per cent, indicates that the situation is far from comfortable. When the rate remains so high and there is very little sign of success by the government in addressing the many supply bottlenecks that are responsible for it, there is always an argument to be made against prematurely using up monetary ammunition. In any event, the wide gap between headline and core numbers imposes severe limits on the space available for easing. The RBI has been saying precisely this ever since it resumed the easing cycle in January. However, given the recent softening in commodity prices - particularly those of crude oil - over the past few weeks, expectations began to build up about an increase in the policy space and the RBI's willingness to use it.
The RBI resisted the temptation. Even as it cut the repo rate, it warned in relatively strong terms about the upside risks to inflation. In the background quarterly macroeconomic report released a day before the policy announcement, it went as far as to say that interest rates could even be hiked! This hawkishness may seem at odds with current macroeconomic conditions, with growth expected to remain sluggish during the year - the RBI's is by far the most pessimistic of the official forecasts - and softer commodity prices taking the pressure off inflation. However, realistically speaking, it is perhaps a bit too early to assume that these prices will stay down; if they do revert to previous levels, a looser monetary stance could very quickly re-ignite inflation, particularly given the rather severe nature of many supply constraints. Beyond this proximate risk lies the additional concern of a very large current account deficit, which will also be aggravated if commodity prices revert to prior levels.
All this exacerbates the sense of despair that has pervaded the economy over the past several months. There is simply no getting round the fact that drastic actions by the government, particularly with respect to supply constraints, are now critical to any prospect of a growth revival. The RBI's policy statements have been saying this for several quarters and this one is even more emphatic on the issue. Unfortunately, this imperative is only matched by the dwindling ability of the government to do anything significant. Under the circumstances, the country should brace itself for more of the same for some time to come. As for the rising clamour for monetary policy to offset the negative impact of other forces, the argument that two wrongs do not make a right appears to be winning the day at the RBI.
