Governor Rajan has kept the policy repo rate unchanged at 7.25 per cent. The market expectations were mixed, with some expecting no change, as there remained upside risks to CPI inflation. The negative WPI and the improved monsoons, did lead to some undercurrents for a downward revision .
The policy documents mentions the rationale for keeping the policy repo rate unchanged. There are three main reasons stated:
The Governor’s caution seems justified in the present context, with the economic recovery remaining weak in India, although consumption demand seems to be picking up in urban areas. The recovery of rural demand, which continues to remain weak, is contingent on a good harvest. As regards investment, the Purchasing Managers Indices had contracted in June, indicative of business pessimism. A weak global demand, as is evident, has led to shrinking export in some industries, while the services sector continues to reveal mixed signals.
This weak economic recovery has to be juxtaposed against the easy liquidity conditions that have been available to understand, why the governor doesn’t seem to consider a cut in interest rates justified- at least not yet! The money market has been in surplus, evidenced by the call money rate (the operational target) being lower than the policy repo rate. This reflects comfortable liquidity conditions, which can be explained on account of increased government spending, seasonal reduction in the demand for currency, together with low credit deployment relative to deposit mobilizations. Further, external sector developments have led to India recording a reduction in current account deficit (CAD) and a rise in foreign capital flows. This has resulted in record foreign exchange build-up providing a cushion for any adverse global shocks.
Based on the above economic development, the RBI has retained its growth projection at 7.6 per cent. Even though the CPI inflation is at a higher level than expected in the June statement, prospects of a reduction in crude prices and near – normal monsoon has provided the RBI a comfort level. Consequently, the RBI has kept its projection of 6 per cent targeted CPI Inflation rate unchanged for January 2016.
While reflecting on the monetary policy two developments are worth mentioning. First, the clamor in some quarters to look at WPI rather than CPI while taking a decision on the policy repo rate reduction. Second, the institutional arrangement through a committee based approach to take a final view on the policy repo rate a lathe FED RESERVE arrangement.
As regards the WPI, much water has flown under the bridge. It may not be possible to turn the clock back, as and when it suits the policy makers. The CPI is a better method than the WPI, as has been debated time and again. Again, as regards the committee approach, in our considered view, the Governor should be the final authority to take decisions. Inflation management is the job of the RBI and the Governor. The Government through its nominees (the so called wise-men) assuming more powers than the Governor may not be entirely wise.
Going by the spirit of the current monetary policy statement, the RBI is watchful of developments in the monetary space. We can only wait for the September 29 policy statement review, when rate cuts may be announced as “Rajan Cuts rates”. Till then the debate and controversy regarding the final authority over monetary space, as stoked by the government’s draft Indian Financial Code (IFC) shall continue.
( The authors are Professors of Economics at the
S.P. Jain Institute of Management and Research, Mumbai. Views are personal.)
R.K. PATTNAIK & TULSI JAYAKUMAR
