The Reserve Bank of India, in its bimonthly monetary policy review on Tuesday, might have disappointed those looking for a cut in the policy rate. RBI Governor Raghuram Rajan flagged clear and present inflationary pressures in the economy to retain the old 7.25 percent repo rate. The cash reserve ratio too remains unchanged at four percent while the statutory liquidity ratio continues to be 21.5 percent (The repo rate is the rate at which the RBI lends funds to commercial banks; cash reserve ratio is the proportion of deposits banks have to hold as cash with the central bank while statutory liquidity ratio is the proportion of deposits banks have to hold in liquid instruments such as gold, cash, government bonds, etc).
Given the uncertainty about the monsoon and the pressure on certain items of food, especially seasonal fruits and vegetables, Rajan probably had good reason to hold the rates unchanged. Monsoon thus far had been uneven but near average, resulting in a higher sowing of pulses. Besides, the commercial banks had failed to pass on the recent cuts in policy rates to the borrowers. Rajan noted that despite a cut of 75 basis points in the bank rate this year alone, there has been a reduction on average of only 30 basis points in the bank lending rate. He would like to see better transmission of policy cuts by banks. Also, there was no noticeable expansion of bank credit despite the three successive cuts in the policy rate. The RBI would ‘monitor developments for emerging room for more accommodation’. Simply put, Rajan would wait till banks report better compliance and an improved off-take of credit before deciding on the next cut in the policy rate. Fair enough.
Given that the non-performing assets of banks are still very high, they have reason to retain the benefit of the policy rate cuts. Also, in the absence of a marked improvement in the economic environment, industry and commerce cannot be undergoing any hardship due to the high lending rates. Unless economic growth picks and commercial banks are able to reduce their NPAs, a sharp spurt in further lending will remain in doubt. Meanwhile, Rajan did well to quell media speculation about differences with the Finance Ministry. His assertion that the RBI and the ministry were on the same page vis-à-vis the policy rate ought to disabuse those claiming rift between North Block and Mint Street. In fact, Rajan touched upon the on-going debate about the proposed monetary policy committee and the denial of veto to the RBI Governor over policy rates. Under the current system, the RBI Governor does have the power to veto the advice received from the committee, but, he said, it was not right to empower a single individual thus. Therefore, he would welcome the rates being decided by a committee, especially because individuals can make mistakes and be vulnerable to pressure while committees could decide these things after receiving internal and external inputs. This should effectively put paid to all talk about Rajan and the ministry locked in irresolvable differences. Meanwhile, RBI Governor sounded optimistic about the economy, pegging the growth rate for 2015-16 at 7.6 percent. Consumption, especially in the urban areas, was picking, up generating hope of a better performance this year.
Low crude and commodity prices in the global markets and concerted efforts of the Modi Government to remove the infrastructure bottlenecks were beginning to show results. Notably, Governor Rajan was not worried by the likely increase in the US rates. The Federal Reserve might raise the policy rate sometime later this year, but this would have little or no impact on the Indian economy. Indeed, fears of a flight of foreign funds from the Indian equity markets were overblown, especially when current woes of investors in China make India virtually the lone developing country with a sound and, still improving regulatory system. In sum, for the economy to pick up factors other than the policy rate are far more important. And given the current logjam in the polity, overall economic sentiment would depend crucially on how the political class is able to work out an arrangement for peaceful co-existence without harming the larger national interest.
