The fifth bi-monthly monetary policy statement of 2015-16 was released by the Reserve Bank of India (RBI) on Tuesday. As almost unanimously expected, the status quo on the repo rate and the cash reserve ratio was maintained. After a series of cuts aggregating to 125 basis points (bps) over the past year, the RBI is clearly wary of further stimulus and the risk of stoking inflationary pressures after the October numbers on the Consumer Price Index. After a rather comforting lull, food inflation is rearing its ugly head again, driven primarily by the prices of pulses. Unlike vegetables, the prices of which generally spike for relatively short periods before being driven down by fresh supplies, higher prices of pulses tend to persist until at least the next crop cycle a year later. So, however frustrating it might have been, it it entirely understandable that the RBI did not want to be seen to be reinforcing that pressure.
The second quarter growth numbers that were released on Monday were clearly discounted by the RBI in its policy assessment. Its forecast for the full year 2015-16 is 7.4 per cent, exactly the rate that was clocked during the second quarter. The guidance provided during the last policy statement was essentially that inflation was expected to harden over the next few months, and that the policy stance would reflect this. That expectation having been fulfilled, the status quo was a logical response. RBI Governor Raghuram Rajan has been voicing concerns about growth momentum and, in particular, the persistence of excess capacity in the economy. But, he clearly sees the need for other policy responses, particularly on the infrastructure front, to deal with that problem. Yesterday's policy statement added to his wish list of policy responses by referring to the need for astute management of the food supply situation to contain the risk of persisting inflation. Unfortunately, long-term solutions to the food inflation problem have not been put into place.
But, perhaps the most significant statement in the policy was the fact that, while the repo rate has been lowered by 125 bps since January, bank lending rates have only come down by half that. Mr Rajan has been highlighting the very weak transmission of policy actions as a significant problem for macroeconomic management. Ultimately, it is lending rates that stimulate or deter demand; if they are not falling, policy actions are going to be ineffective. In effect then, the RBI is putting the entire ball of monetary stimulus into the court of the banking system. Whether they will play along or not is then the big question. On the one hand, the massive burden of non-performing assets that, particularly, public sector banks are bearing is deterring them from taking on any more credit risk. Lending rates apart, they appear reluctant to lend to all but the best borrowers. On the other, they cannot sustain a credit squeeze for very long; losses will keep mounting if they are not generating new business. The entire monetary transmission process risks getting into a stalemate; the RBI will not cut rates until the banks do and the banks just don't want to. This is the basic issue that should be engaging the RBI's attention.