Opinion Cut and miss
RBI misses an opportunity to cut rates. And risks a hardening of stance by the political establishment.
The RBI has the best opportunity to cut rates before the US Federal Reserve starts moving the other way, which could be as early as September.
In the last policy review in June, RBI Governor Raghuram Rajan had spoken of two upside risks to a potential lowering of rates. One was volatile oil prices. The other risk then flagged by the central bank was the prospect of a below-par monsoon and the challenge it poses to managing inflation. Indeed, on both these counts, there has been relief. While oil prices have fallen since then by $10 per barrel, the latest reports on the progress of the monsoon appear to be not very discouraging, with the RBI itself saying that, on net, the monsoon is near normal. Add to that Rajan’s statement in today’s policy review that investment measured by new projects is still weak, primarily because of low capacity utilisation and economic recovery is still a work in progress. In these circumstances, the RBI could have reduced rates by at least 25 basis points, which would have made a lot of difference to many sectors.
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Rajan says transmission of monetary policy is weak, with the lag in impact being three to four quarters. By cutting rates, he would have thrown a gauntlet at banks that have been loath to pass on the benefits of rate cuts to borrowers, given the pile-up of bad debt on their books and the need to cushion such losses, especially with no signs of a strong recovery in sight. The RBI viewpoint is that it has already front-loaded a rate cut in June and would rather wait to see how the uncertainties are being resolved, in terms of banks acting to lower interest rates, the progress of the monsoon, inflationary pressures and a possible raising of interest rates by the US Federal Reserve.
The governor hasn’t dismissed the possibility of policy action outside of the next scheduled review in September, but the current stance of the central bank may leave it vulnerable to attack even by those who have supported it so far in the conflict with the government over autonomy in setting interest rates. The RBI may be fully focused on meeting its inflation target set by the government as part of a new framework agreement. But in a country where the goal is to balance growth with relatively low inflation, this may pose the further risk that the political establishment will harden its stance.
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