Timid love

The RBI’s cautious stance on interest rates has set back India’s recovery timetable


By Mohan Sule
The market is sensitive. At all times it looks for clues to determine future trends. Savvy stock pickers are alert to developments around the globe. A bumper wheat crop translates into soft prices, benefiting companies packaging foods. The rebuilding efforts following natural disasters lead to higher usage of metals and cement. A growing economy would be a copious consumer of fast food and talk time as well as decorative and industrial paints. Nowhere is thinking on the feet so essential than while tracking the yield curve. Supply and cost of money is vital to keep the wheels of the economy moving. Due to global integration, intervention by a central bank anywhere could have a positive impact at home but reverberate adversely elsewhere. Not surprisingly, central bankers are under round-the-clock scrutiny of the market. More subtle is their speech, more is the anxiety to uncover the nuances. However, of late, the statements are becoming ambiguous and open-ended. They seem to rely on historical data than act in anticipation of certain events. This is similar to treating a patient after falling sick rather than taking preventive action to ward off the illness. The US Federal Reserve, for example, has been repeating it will keep interest rates as low as possible till the need arises. The worry about the sustainability of the recovery of the domestic economy comes out clearly. The fall in oil prices will slow down or even stall the pace of growth of inflation to the targeted level of 2% by June to trigger a spike in interest rates. In the emerging markets, however, the pronouncement has been greeted with relief as dollar inflows in search of better yields will continue. But, for exporters, the volatility in the US economy is a cause of concern.

There is comfort that the Fed has spelt out its roadmap to raise interest rates. In that sense there is certainty about its action. However, the helplessness in charting the trajectory of growth and inflation due to confluence of international events is evident. The concern about the unpredictable undercurrents in the global economy is also on display in the actions of our central bank. It unexpectedly cut the lending rate by 25 basis points a couple of weeks before a scheduled policy meet after the wholesale price index slumped to near zero and consumer price index touched the 5% level in December. The market saw the action as the beginning of the rate-cut cycle. Yet, the Reserve Bank of India did not act at its sixth bimonthly review of the monetary policy early February. Instead it reiterated the old message that further easing of monetary policy would depend on data about disinflationary pressures. Also, the quality of fiscal consolidation as well as easing supply constraints of key inputs such as power, land, minerals and infrastructure would be key factors in determining future course. The first condition is understandable in view of the budget to be presented a few weeks later. What is puzzling is the second caveat. Infrastructure modernization is always a work in progress and has long gestation. Does this mean that, unless these two important criteria are met, the central bank will continue to tinker with reserve requirements of cash and government bond holdings?

Reading between the lines it is clear that the RBI has put the onus of economic revival on the government. Nonetheless, it has revealed why it decided to pause in carrying out further rate reduction. Banks have not passed on the earlier cut to customers. Their priority is cleaning up the balance sheet. Many have had to make higher provisions as some loans are beyond recovery. Another reason for the cautious stance was the looming hike in interest rates by the Fed, which could see tapering of inflow of foreign portfolio funds. Hence, the frenetic rush to build up the foreign currency chest. The market is not convinced. It believes rate cuts would enable hard-pressed borrowers to repay some of their loans. This would free funds of banks for lending. By lowering the statutory liquidity requirement of banks, the central bank seems to have acknowledged this problem. Whether banks will feel embolden to lend to infrastructure projects again when they are busy tackling their previous sour loans to this sector is debatable. Instead, another 50-bp cut in the lending rate might have prompted them to pass on at least some of the relief to new clients and at the same restructure a portion of the existing bad loans at softer rates to steadily chip at the mountain of non-performing assets. Improvement in market sentiment due to increase in consumption as a result could have attracted foreign investors. Buoyant equities would have fetched PSUs lined up for divestment better valuations, helping to bridge the fiscal deficit. By its timidity, the RBI has set back India’s recovery timetable.