Expectations are now focused on monetary policy. This is so after the vote on account revealed the governments constraints and inability to take steps that can help the economy to deal with the slowdown. At the time of the last credit policy it was clear that prices were actually falling and would continue to do so,but the RBI took no action. Some argued that this was to keep ammunition for when things got worse. Given the slowdown in the Index of Industrial Production,the drop in exports,declining inflation and the threat of deflation,it is now time for the government to use this ammunition. While the fundamentals of the economy,such as the long-run demographic trends,the relatively small role of the export market in contrast to China and other east Asian economies,these fundamentals need to be supported by correct policies.
In the last credit policy,Reserve Bank of India Governor D. Subbarao did not cut the reverse repo rate even though banks are parking excess funds with the RBI. Now that the growth in credit (year on year) is also showing signs of decline,the central bank needs to act. In the last couple of months we have seen that the RBI has gone back to its over-cautious approach. This could prove to be very risky,as instead of the determinants of monetary policy being forecasted output and inflation,the RBI appears to be looking at year-on-year figures that tell us about the past 12 months. Saving ammunition for the future no longer makes much sense if monetary policy actions taken today take a few months to have an impact. It is now time for the RBI to cut the reverse repo rate,the repo rate and the cash reserve,and thereby provide the economy a much needed fillip. While fiscal policy was constrained by propriety,there are no similar constraints on having an expansionary monetary policy.
Governor Subbarao failed to meet market expectations of lower rates in the credit policy statement. Now he needs to send out a clear message that he will be ahead of the curve rather than behind it. This can help boost sentiment and lower costs for industry.