No easy money in times of high inflation

For a central banker, maintaining the delicate balance between growth and inflation is always a challenging task. It becomes all the more daunting when all the key macroeconomic indicators point towards the ominous scenario of the Great Indian Growth Story being nearly over. With Eurozone still not out of the woods yet and the US economy in a modest recovery phase, the global economic environment is not helping things for the Indian economy. Adding to the economic woes is slowdown in the domestic economy with GDP growth in the fourth quarter plummeting to a disastrous 5.3 per cent, the lowest in the last nine years. Compounding problems further is the double whammy of flat growth in April industrial output and headline inflation crossing the 7.5 per cent mark in May, raising the spectre of days of double-digit inflation not being far off.

Faced with gloom and doom all around, RBI Governor Duvvuri Subbarao has his task cut out when he presents the mid-quarter review of Monetary Policy for 2012-13 on Monday. On one hand, he will have to ensure that the measures the central bank takes boosts growth while simultaneously also help in containing inflation to manageable levels. “It is a delicate balancing act between growth and inflation that the governor will have to do. The policy review this time around will have a tilt more towards protecting growth than controlling rising prices,” says D K Joshi, chief economist, CRISIL.

This is not the first time that Subbarao will be doing a tight ropewalk. Having been appointed as the 22nd governor of the RBI in September 2008, the 1972-batch All India Civil Services Examination topper’s tenure since taking over the top post at Mint Street has been far from being a smooth ride.

Having been there and done that, Subbarao has executed the roles of a saviour and facilitator quite adeptly till now. At the same time, he has also built a reputation for not cowing down to industry’s wishes every time. With inflation spiralling out of control and remaining above the crucial 9 per cent level, he hiked interest rates 13 times successively between March 2010 and October 2011. Even as inflation cooled down to an over two-year low of 6.55 per cent  in January, he did not heed to industry’s demands for easing of monetary policy stance.

But when he finally did relent, it was more than what India Inc had bargained for. Announcing a higher-than-expected 50 basis points cut in repo rate to 8.0 per cent from 8.5 per cent in RBI’s Annual Monetary Policy for 2012-13 in April this year, Subbarao had said the move will stabilise growth around its current post-crisis trend, contain risks of inflation and put more money into the banking system.

While the reduction in policy rate helped in achieving the objective of enhancing liquidity in the system, it did not yield the desired results from the view of stabilising growth and curbing inflation.  Things in fact have worsened post that.

WILL HE OR WONT’ HE?

With the economy in bad shape and things not expected to turnaround quickly, the big question now is will Subbarao do an encore by reducing repo rate further or will he maintain the status quo?

Going by what industry experts and analyst have been debating, there is a strong expectation that RBI will cut the repo rate by atleast 25 basis points.

“As far as repo rate is concerned, I expect RBI to be a little more proactive in its actions. We expect a 25-50 basis points cut in repo rate,” explains Chennai-based Indian Overseas Bank’s Chairman and Managing Director M Narendra.

In fact, Prime Minister’s Economic Advisory Council Chairman C Rangarajan too believes that the need of the hour is a cut in interest rates. “We really need to make the investors and entrepreneurs convinced that we can get back to higher growth path. That is really the key to improving the investment in the private sector. In this process, a cut in interest rates will help but all that depends on how inflation behaves,” he says.

Addressing a conference in Hyderabad earlier this week, Subbarao had indicated that growth remains secondary. “You cannot control inflation without sacrificing some growth. After all, you have to contain demand. When you contain demand, growth comes down. So there is no way of bringing down inflation without sacrificing some growth,” he said.

“As the governor’s comments come right before the RBI’s June 18 policy meeting, they suggest that the RBI is unlikely to ease aggressively next week, if at all. We are expecting a 25 basis points cut in the repo rate and no change in the cash reserve ratio, in line with consensus,” says Sonal Varma, economist, Nomura Financial Advisory and Securities (India) Private Limited.

CRR CUT SUPPORTERS

While there is one school of thought that advocates a cut in interest rates, the other believes a further reduction in Cash Reserve Ratio (CRR) will help in turning around things faster.

“If there is a CRR cut, it would improve the profitability of banks and it would reduce the requirement of government to capitalise the banks. For example, if there is a 1 per cent CRR cut, it will release `60,000 crore in the system which would help the banks to earn `5,000 crore of additional profits. Out of `5,000 crore, the banks would on an average pay 30 per cent tax which is `1,500 crore. The balance `3,500 crore goes into the banking system,” explains Pratip Chaudhuri, chairman, State Bank of India.

Last week, industry association CII had pushed for a 100 basis point cut each in repo rate and CRR.

“We now expect RBI to ease repo rate further by 50-75 bps in FY13 (along with  a 100 bps of CRR cut), and bring forward our expectation of next rate cut to June 2012 policy as against September 2012 earlier,” says Shubhada Rao, chief economist, YES Bank.

Whether or not Subbarao cuts repo rate or brings down CRR further on June 18, one thing is for sure that going ahead the central bank will now have to increasingly look at various other options to boost growth. The government must understand that RBI’s primary role is to regulate the banking system. It is not there to do firefighting on behalf of the government. It’s over to you now, doctor.