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Central bank leaves no excuse for govt

W ith a single bold action, the Reserve Bank of India, or RBI, has silenced its critics, regained initiative and set a tough agenda for banks and government before they can ask it to do more.

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By cutting repo rate 50 bps instead of the widely-expected 25bps, RBI has silenced all critics, including those within the government, who have been accusing it of holding back growth. A little moderation in inflation, steep decline in industrial growth, uninspiring investment climate and low level of business confidence have prompted the apex bank to cut the policy rate.

However, RBI remains concerned that the economy conceals substantial inflationary pressures — a deteriorating current account and pressure on the rupee, a slip in fiscal correction, the inevitable hike in petroleum prices, and more. Despite these concerns, the central bank took a chance with a bigger cut because that, it thought, would be transmitted more effectively than a small cut.

Banks are under pressure to cut lending rates. Recently, RBI lowered the CRR by 125 basis points to 4.75 per cent and bought bonds worth Rs1.3 trillion; the pressure on bulk deposit rates has eased. Now, by doubling the borrowing limit under the Marginal Standing Facility to two per cent of their deposits, RBI has done its best to ensure that banks pass on the rate cut since, in case of exigencies they can dip into their SLR kitty.

However, the bad news is that for several months now, the money markets have been short of liquidity and banks have been compelled to borrow at very high rates in the wholesale market — three-month Certificates of Deposits (CDs) have fetched as much as 10.25 per cent.

More pertinently, bank deposit growth is languishing — deposits in the six months to March 2012 increased by just three per cent over the base at the end of September 2011, the lowest half-yearly growth in the last decade. Banks cannot afford to cut lending rates without reducing deposit rates. But if they lower deposit rates, it’s possible that savers will switch to savings instruments which offer tax breaks. Indeed, money is expected to remain in short supply for the better part of this year, with the government looking to mop up a gross Rs5.7 trillion. Unless RBI supports the market by buying back bonds, yields on the benchmark bonds are unlikely to soften.

Having announced the rate cut, RBI has very clearly put the ball back where it belongs: with the government. It has told the government that budget numbers for fiscal deficit are dependent on capping subsidies. Since oil prices are unlikely to come down significantly in foreseeable future, a change in the administered prices of petroleum products is overdue. The policy statement adds that the fear that fuel price hike would make inflation spiral out of control are exaggerated. It quotes survey data suggesting that companies do not have great pricing power currently. Little should stop the government from “biting the bullet”.

The RBI has pointed out that the main reason for the economic slowdown in recent quarters is the emergence of supply bottlenecks in infrastructure, energy, minerals and labour. “A strategy to increase the economy’s potential by focusing on these constraints is an imperative,” it adds. The central bank has laid out what needs to be done now: reform of administered prices and subsidies to bring down the fiscal deficit; and growth-boosting supply-side reform. By doing more than what was expected of it, the Reserve Bank left the government with no excuses.

Views expressed by the author are his own and do not reflect the newspaper’s policy

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