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RBI remains on course, but misses the point

As expected, Reserve Bank of India (RBI) in its quarterly review of monetary policy has not reduced its benchmark lending rate (repo) or the cash reserve ratio-the portion of bank deposits to be compulsorily kept with the RBI without earning any interest.

The only change it made was to lower the statutory liquidity ratio — the proportion of bank deposits that has to be mandatorily invested in government or approved securities — from 24 to 23 per cent.

Far more significantly, it has raised its inflation projection for April 2013 from 6.5 per cent earlier to seven per cent, while reducing the growth projection for the current year from 7.3 per cent earlier to 6.5 per cent. In doing what it has done, therefore, the RBI has as before accorded priority to “containing inflation and lowering inflation expectations”. This is understandable. The wholesale price inflation has remained above seven per cent for several months. The below-normal monsoon has already induced a fresh bout of increases in food prices, and world oil prices are high. The RBI can claim credit for staying the course on inflation. The point, however, is the ineffectiveness of its policy in combating the type of inflation being experienced. The apex bank itself acknowledges that the sources of inflation-food, driven by demand and the monsoon, and fuel, driven by international prices — are beyond the control of monetary policy.

Meanwhile, RBI’s bookish approach has taken a heavy toll on economic growth. The GDP growth has been decelerating over four successive quarters to 5.2 per cent in January-March, industrial output has risen by a measly 0.8 per cent in April-May, and capital goods production has seen a contraction in nine out of the past 11 months. The last figure points to a complete drying up of investments in the economy.

The Reserve Bank has sought to address these concerns by reducing the SLR. It wants to ensure that “liquidity pressures do not constrain the flow of credit to productive sectors of the economy.” This measure, though in the right direction, has little meaning when the cost of funds matters more than its availability. The financial system does not signal a liquidity crunch at present.

However, there are worrying signs that several enterprises small and large are finding interest payments increasingly onerous. An Axis Bank study of April-June 2012 quarterly results declared by 824 listed companies indicates that rising interest costs continue to retard profit growth. Their cumulative sales at Rs6.18 trillion show an increase of 17 per cent over the corresponding quarter of 2011. Their operating profits (profits before depreciation interest and tax, or PBDIT) have also increased in tandem by 17 per cent. The net profits, however, are up by just under 10 per cent, mainly because interest costs have ballooned by over 30 per cent. As percentage of sales, interest cost has moved up to 17.8 per cent in 2012-13 from 16.1 per cent of sales in 2011-12.

RBI is right in recommending non-monetary policy action to encourage investment: removing constraints to FDI, addressing bottlenecks in the infrastructure space and curtaining fiscal deficit to give PSU investments a big push. The problem is that these solutions can only be undertaken in the medium-to-long run.

Much hope is now pinned on the return of P. Chidambaram to the finance ministry. Similar hopes were entertained when the Prime Minister Dr Manmohan Singh took over finance portfolio after the exit of Pranab Mukherjee. Those hopes were belied. It may be the same story again.

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