Tuesday, June 19, 2012

Monetary Policy Points to Government’s Inaction to Clear the Bottlenecks

RBI Governor
The Indian central bank on Monday has given a clear signal to the government that its task is to mend monetary policy to check inflation, rest has to come from the government through reforms. This was consecutively second occasion when  the Reserve Bank of India (RBI)  has gone away from the expectations of the market, which was expecting a cut by 25 basis points (bps). The same RBI had  surprised market with a larger-than-expected 50 bps rate cut in April.
Since 2010  UPA-II government has failed to nail the inflation. Burden to bringing down the rates by regulating the flow of money fell on the central bank. As a result RBI raised its lending rate 13 times between March 2010 and October 2011. The trend was given a reversing mode in April by slashing its key repo rate by 50 bps and a two-stage CRR cut of 125 bps since January.
Snubbing aside the concern of slowdown in growth  RBI opted  status quo and said, “ Its assessment of the current growth-inflation dynamic is that there are several factors responsible for the slowdown in activity, particularly in investment, with the role of interest rates being relatively small”.
RBI took initiative with  a reduction of 50 basis points in April  because it expected that the government would take steps to reduce the fiscal deficit and take other “supply-side initiatives”. The government has been irrational in adjusting the fuel price and subsidy on petroleum products. The government’s inability to rein in subsidies is “crowding out public investment”.
While declaring the mid quarter monetary review RBI governor clearly pointed out that  failure of governance is responsible not only for slowdown in development but also for the inflation. This has made task of the central bank difficult.  When slowdown is combining with inflation  the government should have taken apt action to augment supply. The government is responsible for the current account deficit as well. The widening current account deficit is  a pointer to the urgent need to resolve the supply bottlenecks. RBI’s stance seems to be that unless the government does something to reduce the fiscal deficit and ease supply constraints, it cannot reduce interest rates.
Reacting to the monetary  policy CMD of Canara Bank said,“There will be no cut in the lending rate. We are already tight on rates. Margins are tight and we cannot reduce the deposit rates and thereby lending rates. We would be awaiting the next policy action.”  The central bank’s next policy announcement will be made on 31st  July.
If the interest rates remain high will that affect the growth aspects of the country? By common sense, yes.  There are many other factors before coming to them, let us see if the nominal rate of interest is same as the real interest.  Nominal rate of lending is 14.5% to 15%, average – 14.75%.  Nominal deposit rate is 8.75% to 9.25% , average 9%.  Industry cost will have impact of the whole inflation factor which is 7.55%.  This gives real rate of lending to be 9.20%.   The deposits get discounted by Consumer Price Inflation which is 10.4%, making the real deposit rate negative 1.4%  Hence to cut down the deposit rates seems difficult, making to bring down the lending rate impossible for time being.
What can be the driver to industrial growth?  The government had framed National Manufacturing Policy last year.  It had set a target  of raising the share of manufacturing in (GDP) to 25 per cent, (creating) 100 million jobs.  If policy reforms to cut red tapism and speedy clearances can be brought, scenario can change.  In practice this is against the philosophy of Congress party.
Another factor of pushing demand can be depreciation of rupee; This can drive the export led demand.  But global macro economy factors  in near future will not support this theory. Meaning that keep your fingers crossed till the presidential election and realignment of coalition in centre.

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