The Reserve Bank of India’s latest bi-monthly monetary policy statement is as dovish as it can get. The central bank has, after a long time, talked of a likely “change” in its monetary policy stance “early next year”, which could even be outside the normal bi-monthly policy review cycle. The current weak demand conditions and the rapid pace of recent disinflation are “factors supporting monetary accommodation”, it has said. It is right to say so. Global crude prices plunging nearly 30 per cent since the last policy review on September 30, annual inflation rates dipping to 1.8 per cent at the wholesale and 5.5 per cent at the retail level, non-food credit expansion by banks slowing to a near decade low, and fresh investments in the economy practically drying up are all indicators of the balance of risks clearly shifting to growth. Even the RBI is now forecasting consumer price inflation for March 2015 at 6 per cent — a level it was targeting only for January 2016.
Then why has the RBI not reduced policy rates this time? At 8 per cent, the central bank’s current repo or overnight lending rate to banks is just a shade above yields on 10-year government bonds, which have fallen from 8.51 to 8.02 per cent since September 30. This, and the fact that banks’ average borrowings from the RBI’s liquidity window have come down from over Rs 71,000 crore in July-September to under Rs 48,000 crore in October-November, points to the repo rate being kept artificially high. When liquidity conditions are ruling easy — which is itself a result of a slowdown-induced weak credit demand — one would have expected a rate cut. And in a softening inflation scenario, this would hardly have amounted to populism, which arises only from policy decisions being divorced from market realities.
The only justifiable reason for the RBI to keep policy rates unchanged is that any reduction now might signal a weakening of its anti-inflationary credentials. What would happen to its “credibility” if a resurgence of inflation forces it to raise interest rates all over again? But these kinds of risks are impossible to predict, just as nobody thought oil prices would crash so much even two months ago. It is better to focus policy attention on immediate threats, which today stem more from growth than inflation.