Reserve Bank of India Governor Duvvuri Subbarao has a tough decision to make. The rate policy expected today comes as the RBI’s twin responsibilities, growth and inflation, spiral out of control, as Table 1 shows. Even as GDP shrinks quarter after quarter, inflation has stayed consistently high. However, the wholesale price index for manufacturing (“core” inflation) has dipped slightly, even as the consumer price index has spiked back up to double-digit levels.
As Table 2 shows, the slowdown in growth can be attributed to consistently anaemic industrial production over the past year. Industrial growth is barely in positive territory, as of April. Nor is the future sanguine; the HSBC Purchasing Managers’ Index, widely tracked as an index of optimism, seemed about to recover from its precipitous decline early this year, but that hope was an illusion, as Table 3 shows.
Yet, the RBI cannot help but consider that monetary policy might be ineffective, drowned out by profligate fiscal policy. As Table 4 shows, Government of India borrowing has been consistently high since the financial crisis of 2008. In effect, this keeps interest rates high, as investors flock to government bonds. As Table 5 shows, yields on 10-year government bonds, though down somewhat of late, are still above 8 per cent, making a pass-through of a repo rate cut into the cost of capital tougher to ensure.(Click here for tables)
The RBI will also have one eye on the real interest rate’s impact on dollar inflows and reserves – as well as on liquidity in the money market. After spending to defend the rupee in December and January, the RBI has been careful of its reserves of late, as Table 6 shows. And, as Table 7 outlines, it has tried to fix the severe liquidity deficit that was visible until earlier this year.
