The upcoming RBI policy meet will be an interesting one to watch out for. The monetary policy has been quite hawkish on interest rates and inflation targeting of late. Based on their statements after the policy meets, one can understand that the majority of the committee is led by a very conservative mindset that is more concerned about avoiding inflation rather than stimulating growth. With signs of an economic slowdown hitting home, the policy meet may just have come at the right time.
If the government had its way, it would prefer a significant rate cut which would enable higher private investment. Yet, we have seen time and again that the economy does not function that way. It usually takes months before RBI rate cuts are actually transferred to the borrowers and that too in a Rajiv Gandhi style, only 15 paise reach the public for every rupee spent by the government. Banks have had surplus liquidity since demonetization which can be evidenced by low interest rates on deposits. However, banks have burnt their hands and the NPA problem refuses to die down making ambitious lending even more dangerous.
A narrative is being created today that Indian economy is in the doldrums like narratives created before, that of India being intolerant or cow vigilantes and lynching mobs having a free hand. The fact is that when structural reforms like GST and demonetization are undertaken, you cannot expect the economy to absorb it without shocks. The same way that when you are driving a car on the highway and your engine overheats, you can’t expect it to correct itself while you go on driving at 100kmph. The economy needs a start-stop button to reset itself.
Yet, what is important to note is that a stimulus is not the answer to a restart. The government is obviously aware that breaching the fiscal deficit is not the answer to its media-hyped woes. It must therefore hope and rely on a tight-lipped monetary policy committee to provide some easy credit into the market. The MPC on its part must again focus on how its inflation reading has been faulty in the past. Former Finance Minister and full-time critic of the current finance minister, P. Chidambaram has also advocated a cut in rates. Chidambaram actually advocated a 100 basis points rate cut but was quick to realize that the MPC cannot stomach a rate cut so big, lest it be seen as being in bed with the government.
The MPC must not worry about media opinions about its independence or competency. A bunch of arm-chair economists and prejudiced media personnel cannot decide monetary policy at the highest echelons of Indian economics. That a rate cut is required seems to be obvious to the government, but one believes that the MPC would be unwilling to cut rates at two back-to-back meetings even though it may be of the lowest possible number i.e. 25 basis points.