Game, Set and Match To…?
The ball is now firmly in the central bank’s court. It is for Raghuram Rajan to respond suitably
Had this been a tennis match, one could probably have cheered and said ‘Bravo’. Consider this. The RBI lobs the ball to the government, says it can act only if the latter sticks to the fiscal roadmap. The government lobs it back, adheres to the 2015-16 target and sticks to the 2016-17 target. It then goes one further: reduces interest rates on small savings and follows it up with some fairly hard-nosed reforms.
Game, set and match to the government for successfully — and repeatedly — lobbing the ball to the RBI? Not quite.
For one, this is not a tennis match. For another, what is at stake is economic growth, the future of millions of youth desperate for jobs that only strong economic growth can deliver.
FM Ticks All the Boxes
From the RBI’s perspective, it was perhaps not meant to be like this. When governor Raghuram Rajan lobbed the ball to the government in February 2016, saying “structural reforms in the forthcoming Union Budget that boost growth while controlling spending will create more space for monetary policy to support growth”, the unspoken statement seemed to be that the RBI had done its bit. It was for the government to respond.
Well, the government has responded. With the finance minister sticking to the fiscal target, the US Federal Reserve staying put on interest rates and turning decidedly dovish for now, and interest rates on small savings coming down sharply, the pressure on the RBI to respond appropriately has increased tremendously. Especially since macroeconomic fundamentals remain iffy even as inflation numbers seem within reach of the RBI’s target of 5% for March 2017.
So, the question is not so much whether the RBI will cut the repo rate tomorrow as whether it will content itself with a 25-basis-point reduction. Or go in for more aggressive monetary easing. The options range from a 50-basis-point cut in repo rate to a cut in cash reserve ratio to a new, more realistic liquidity framework.
As Rajan weighs the options, the clincher, as always, is the growth-inflation trade-off. Wholesale price inflation has been in negative territory for — hold your breath — 16 months. Consumer inflation was well below the RBI’s target for January 2016.
So, has the RBI been hoisted by its own petard? In monetary (as in fiscal) policy, timing is critical. Today, with the benefit of hindsight, it is hard to shake off the nagging suspicion that excessive focus on beating down inflation blind-sided the RBI.
It ignored the flip side of, first, cutting rates belatedly, and then keeping liquidity tight, crimping an already leaky transmission mechanism that impeded full pass-through of monetary signals. This, combined with its insistence that banks clean up their balance sheets in a relatively short time span, despite an economic downturn, turned banks risk-averse. This led to the unintended effect of killing a nascent recovery.
Can the RBI make up for being behind the curve (read: failing to cut rates more sharply earlier) by cutting more aggressively now? Will a larger-than-expected rate cut spur grow- th? Could it spur inflation? That is the RBI’s dilemma. There is no knowing for sure.
Given the current growth-inflation dynamics, chances are it will be positive for growth and do less damage to inflation. But that could well change, as Rajan knows all too well. It is a risk, but one worth taking. Even if means he has to ignore his instincts and give growth a chance.
Guv, Go for Gains
Time is running out. The Fed will raise rates this year, even if at a slower pace. Commodity prices, soft for now and likely to remain so for a while, could reverse. Early indications are that the monsoon, which could play spoilsport and push up food inflation, is likely to be normal. So the RBI has a small window of opportunity.
Moreover, as things stand, Rajan has only two more bimonthly policies to go before his term ends on September 4. What’re the odds that the governor will return the finance minister’s carefully placed shot with a stronger-than-anticipated backhand? It’s hard to say. Remember, this is a governor who, in his very first public statement on September 4, 2013, took care not to rule out surprises. “A central bank should never say ‘Never’.”
Remember also, that many of the five pillars Rajan outlined in October 2013 remain works-in-progress. The monetary policy framework has been strengthened. But this is yet to receive legislative sanction. More players have got banks licences. But licences are still not on tap.
Financial markets have been deepened. But this is, necessarily, an ongoing process. Financial inclusion has improved, thanks to Jan Dhan. But micro, small and medium enterprises (MSMEs) remain excluded. As for the fifth pillar — strengthening banks’ hands against recalcitrant borrowers — we still have a long way to go. We may even have paid an unintended, but heavy, price.
Given this mixed record, will Rajan go against conventional wisdom and give it all he has, risking his record on inflation? Or play safe with a 25-basis-point cut in repo rate? Given the governor’s innate conservatism, chances are he will prefer the latter. The loser, once again, could be the nascent economic recovery.
Strumming up some courage