RBI's third quarter review of monetary policy for 2012-13 came out on 29th January 2013. This is an attempt at reviewing RBI's review. The review saw Indian economy as slowing and hence RBI further reduced its growth forecast for the FY 2013 from 5.8% to 5.5%. This is a result of a no. of factors including a slowdown of investment, a weakening of consumer spending, persistent inflation and a recovering but still gloomy global economy with threats looming from all sides. While it seems RBI is finally comfortable with the inflation situation as the review mentioned inflation to be slowing down and stabilizing, the central bank is still cautious about the twin deficit. One area of concern that was highlighted in the report was slow growth of money supply despite RBI's easing of CRR a no. of times. This may be because of hawkish attitude of banks due to growing NPAs but, it definitely is one of the reasons of slowing growth.
As action measure RBI reduced its policy rate from 8.0% to 7.75% with immediate effect and reduced CRR by 25 basis points and it stands at 4% of NDTL (Net Demand and Time Liabilities) from fortnight starting 9th February 2013. A no. of bankers and corporate executives have termed this action as per their prediction. However, most of them predicted rather demanded rate cut before every review and even the govt. had joined the chorus in last review. In fact this is one of the reviews before which RBI was least bugged to grace economy with rate cut. I suppose the governor with his tough stance had made clear that rates would be cut only when RBI was comfortable on inflation front. So, this rate cut fulfills expectations more than predictions.
Economic Times editorial on 30th January, 2013 mentions Central bank to be at odds with itself. This is so because RBI eased rates even as the CPI based inflation increased to 10.5% in December 2012. As I interpret it RBI gave a rate cut as it sees inflation as slowing down and stabilizing and so it wants to signal its inclination towards promoting Growth. Growth and Stabilization are twin objectives of Central Banks in developing countries. RBI now seems comfortable on inflation front and that is why it is focusing on growth front. CPI based inflation was mainly fueled by food inflation, a spur that has a lot to do with supply related bottlenecks that can't be guided via money supply. However, Core inflation showed stabilizing signs as gauged by both CPI and WPI and that is the reason RBI went ahead with rate cut to accommodate growth concerns.
One of the major objective of RBI's monetary policy stance is to anchor medium term inflation expectation through credible action and given the stubbornness it showed by refusing to reduce rates when growth was slowing, its credibility has been established. Markets know that this may not be start of an easing cycle if concerns regarding twin deficits are not properly addressed. This easing is only because inflation seems to stabilize for now. This will do well to anchor inflation expectation towards lower level despite rate cut if other economic variables remain under control.
Other concern that led to rate cut was slow growth of money supply. Liquidity conditions have remained tight despite RBI's reduction of CRR as well as its open market operations. This has restricted credit flow and hence negatively impacted investment. Thus, impacting growth adversely. In an environment where banks are hawkish a rate cut will give them reason to increase credit flow. On the other hand CRR cut will ease liquidity pressure by pumping 180 billion of primary liquidity into system. Thus, both policy actions together will help in improving investment scenario.
RBI has initiated the play and set the stage for govt. to play its part via Annual Budget. Let us hope something magical comes from fin min's briefcase to revive the economy.
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