RBI's Policy Stance: Will Choosing Practicality Over Sentimentality Help?

The Reserve Bank of India (RBI) announced its second quarter review of the monetary policy 2012-13. This has turned out to be contrary to what was expected. The central bank left the repo and the reverse repo rates unchanged at 8 per cent and 7 per cent respectively. However, it again slashed the Cash Reserve Ratio (CRR) by another 25 basis points, bringing it to 4.25 per cent. This would effectively inject around Rs 17500 crore into the system, helping the banking sector to resolve its liquidity issues.

It has also revised the GDP growth estimate downward by 70 basis points to 5.8 per cent for FY2013 and the inflation estimate upwards by 50 basis points to 7.5 per cent for March 2013. In April 2012, the RBI had forecasted the GDP growth to come in at 7.3 per cent and inflation to be at around 6.5 per cent, which was later revised downwards to 6.5 per cent and 7 per cent respectively in July. This is the second revision of the key indicators, which clearly reflects the RBI’s cautious stand on the economic front.

The deposits growth estimate for FY2013 has been left unchanged at 15 per cent but that for advances growth has been lowered by 100 basis points to 16 per cent. According to the report, the growth of deposits decelerated with a moderation in interest rates, especially the term deposit rates. On the other hand, a slowdown in investment demand, especially with regard to infrastructure, and lower absorption of credit by the industry in general has been hurting credit growth. During the first half of 2012-13, the modal deposit rates of scheduled commercial banks declined by 13 basis points across all maturities and the modal base rate of banks also declined by 25 basis points.

The following are some of the key viewpoints of the RBI as announced at its monetary meet:

• According to the central banker, liquidity infusion by central banks in advanced economies is not a substitute for robust structural solutions that can aid economic recoveries.
• Global risks have increased further and domestic risks have been accentuated. The demand for investment has considerably slowed down, and there has been an acute moderation in consumption spending along with continuing erosion in export competitiveness. This, accompanied by weakening business and consumer confidence, has led the baseline projection of GDP growth for FY2013 being revised to 5.8 per cent.
• WPI inflation was revised higher to 7.5 per cent for March 2013. An important driver of inflation is the upsurge in both rural and urban wages, which are exerting cost-push pressures. Further, as under-pricing in several products gets corrected as part of the fiscal consolidation process, suppressed inflation is being brought into the open. Inflation is expected to rise somewhat in Q3, before beginning to ease in Q4.
• It has been decided to increase the provision for restructured standard accounts to 2.75 per cent from the existing 2 per cent.

We, at DSIJ, do not expect any major rate cuts either on the deposits or the advances front on an immediate basis from the banks. In DSIJ Vol. 27, Issue No. 10 (dated May 6, 2012), we had stated that the rate cut of 50 basis points in the repo rate effected in April 2012 would be the only cut for CY2012, and we continue to hold the same view. With inflation still on the higher side, we would not be surprised if the RBI maintains status quo on the key rates in its next meet scheduled on December 18, 2012 as well.

What emerges from the RBI’s actions is that there are clear differences of opinion between the regulator and the Finance Ministry. While the Hon. Finance Minister has hinted that the government would walk alone to face the growth challenge, the RBI governor was heard to be saying, “We are as much concerned about growth as inflation, only our balance is shifting”. We believe that our government is playing a very hands-on role at present to revive the economy. The RBI governor has probably taken the right stance once again, by placing practicality over sentiment. But isn’t there a need to support the government in its efforts to put the economy back on the growth path?