There is a striking divergence of monetary policy dilemmas facing the US Federal Reserve and the Reserve Bank of India today. Fed chair Janet Yellen knows that the US central bank’s policy rate, at near zero levels since December 2008, would need to be raised at some point. But before that, she wants more “decisive evidence” of sustained economic recovery and improved labour conditions, besides “reasonable confidence” about inflation rising from zero to the targeted 2 per cent over the medium term. It is quite the opposite with the RBI, which has refrained from cutting policy rates beyond homeopathic doses of 25 basis points (bps), given its greater worry over CPI inflation overshooting the target of 4 per cent for 2016-17. In both cases, the criticism is about their being behind the curve — the former in underestimating the dangers from a prolonged ultra-cheap money policy and the latter in not recognising the depth of the ongoing slowdown.
Last week saw the Sensex rise 891 points after hitting an eight-month low of 26,307 the previous Friday. Much of this was a relief rally — on account of the Fed’s decision not to hike rates on Wednesday, combined with the monsoon’s unexpectedly good performance so far and the government only moderately increasing minimum support prices of crops, which, many believe, may embolden the RBI to undertake more aggressive monetary easing. Such optimism is probably overdone. While the country may have received 16 per cent surplus rainfall till now, the fact is that the four-month monsoon season has just begun. From an agricultural perspective, it is the rains in July and August that really matter more than June. How the monsoon fares in those two months — the met department’s forecasts aren’t too rosy — would decide the course of food inflation and rural incomes in the coming months. Likewise, it is foolhardy to imagine the Fed putting off interest rate hikes for too long. Even if that may not happen in, say, September and the increases won’t be sharp, one has to be prepared for its inevitability and resulting impact on fund flows to emerging markets.
Rather than clutching at straws, it would be prudent for both investors and policymakers to get real. The overwhelming truth before us is that corporate earnings are still weak and there are simply no investments happening on the ground. With India Inc having neither the resources nor the stomach to invest now, the government has no alternative but to take up the slack — through large-scale redirection of expenditures from subsidies and wasteful current consumption. The RBI, too, should realise that minus 2 per cent wholesale inflation for four consecutive months warrants repo rate reductions by full percentage points, not mere bps.