Hold it steady

The monetary policy committee (MPC) of the Reserve Bank of India (RBI) meets on October 3 and 4. This meeting of the MPC takes place amidst considerable concern about the rate of economic growth of the Indian economy, which fell to 5.7 per cent year-on-year in the latest data print — capping six consecutive quarters of slowing growth. Many have expressed the opinion that an expansive monetary policy is the solution to the growth problem. The level of real interest rates, it is argued, is too high for investment and thus growth to recover. These arguments further point out that the policy rate is at 6 per cent while the inflation rate came in for August 2017 at only 3.4 per cent, up from the 2.4 per cent in July, which leaves ample space for monetary easing. Meanwhile, the medium-term target for inflation is just 4 per cent. In response to this and similar criticism that it was not responding to low inflation and that its inflation forecasts had been off for some time, the RBI’s MPC — during its last policy review, in August — cut rates for the first time in 10 months. The policy rate was cut by 0.25 percentage points to 6 per cent, the lowest rate in almost seven years.

The Union finance ministry has also indicated that it believes a rate cut is warranted by current circumstances, and without doubt Finance Minister Arun Jaitley repeated some of these arguments to RBI Governor Urjit Patel when they met recently. The predicament of the Indian economy and the sustained investment slowdown are certainly a matter of concern. However, the RBI should nevertheless stand firm and hold interest rates steady at its October meeting. It is clear that the inflation rate is inching up after various hits to demand, and its trajectory is far from certain. Unless expectations of inflation have significantly weakened since the last survey, it would be wiser, given the uncertainty, for the RBI to avoid cutting rates to push growth. Not only would a rate cut lead to uncertain consequences for inflation, but it is also likely to fail in boosting economic activity. Balance sheets of banks continue to contain stressed assets, and companies that should be investing are still debt-ridden — until this variation of the “twin deficit” problem has been resolved, a minor cut would hardly boost economic activity.

The government must stop looking to the RBI to bail it out. If it wishes to swiftly revive growth, it should act on its own. In particular, it must work on improving the quality of government expenditure — further reducing wasteful spending on unproductive activities, and replacing that with productive investment in infrastructure and in human capital. Most importantly, to restore business confidence and a proper investment climate, administrative and structural reforms are needed. Sustained movement on such reforms, which is totally within the central government’s powers, will have a far more meaningful impact on growth than anything that the central bank’s monetary policy committee can do under current circumstances.

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