Reserve Bank waits for better inflation signal

For the government, boosting growth may well be a priority, especially after two consecutive years of sub-5 per cent growth and with inflation on a downward trajectory on the back of crashing global crude prices. But the RBI, as Tuesday’s review indicated, wants to be doubly certain that the inflation decline now being seen is real and durable.

Also, it wants to know whether the Centre is on course for achieving budgeted  fiscal deficit target of 4.1 per cent of GDP this year. The RBI is afraid that any relaxation of its stance should be neutralised by deviations from the path of fiscal consolidation. The worry lines on the latter count stem primarily from tax revenue collections so far this fiscal not being so buoyant, alongside the Centre’s failure to mop up any funds through stake sales in state-owned firms.

But there are other reasons why Rajan may have played it safe this time. For one, there is no certainty that rate cuts will actually help revive investments, given the larger policy-related constraints in areas such as mining, land acquisition and infrastructure.

While a rate cut could boost sentiment, and even translate into lower borrowing costs for firms, the central bank appears to believe that the larger structural constraints are a more significant drag on growth and investments. So, it would like more co-ordinated policy efforts from the government to ensure what it calls a durable revival of investment.

Besides, there is hardly any demand for loans, as reflected in bank credit growth being close to a decadal low.

Add to that abundant liquidity in the system — banks being flush with funds and deposit growth outpacing that of credit — there is much that a policy rate cut can do to change things. Moreover, India’s top companies are sitting on a huge cash pile — estimated at nearly Rs 2,50,000 crore for the BSE-100 firms, excluding banks.

The RBI, in short, wants inflation to be low and government finances in order. This, along with more serious demonstration of commitment to second-generation reforms from the government, will set the stage for the next investment revival. Lower interest rates would help precisely at that point. A clearer picture of these would emerge when the government presents its first full Budget towards end-February — by which time it will also be known whether the decline in inflation being seen is structural and enduring.

The RBI wants to make sure that the trends visible now are sustained and for real, so that a repo cut now does not have to be followed by hikes a few months later. “We will act when we are more certain about the process,” Rajan said.

On its part, the finance ministry said that it was encouraging that the RBI had taken note of the structural change in the outlook for inflation and that the government was looking forward to the RBI for supporting the revival of growth and employment — a nuanced way of seeking a cut in rates.

In the late 1990’s, when inflation was in double digits, the then RBI Governor C Rangarajan raised rates aggressively. Though growth slowed till the early 2000s, it rebounded in 2003-04 and rose over the next four years. So, even while the economy grew at well over 8 per cent, inflation was under control thanks to earlier prudence with regard to monetary policy. It is that stable inflation path that the RBI appears to have in mind.