It is tempting to believe that the policy priority of the Reserve Bank of India may have shifted to encouraging growth when it unveiled its third quarter review of monetary policy on January 29. The policy statement of the central bank did suggest just that, but in reading through the entire document, one cannot help but conclude that the shift is contingent and conditional upon a couple of important factors. As the RBI governor, Duvvuri Subbarao, had indicated in the mid-quarter review in early December 2012, the policy interest rate — the repo rate (at which banks borrow from the central bank) — was lowered by a quarter of a percentage point or 25 basis points to 7.75 per cent. As a pleasant little bonus, he also reduced the cash reserve ratio by 25 bps, releasing another Rs 18,000 crore into the banking system that could be used to lend to industry. The measures help both banks — they will now be able to earn money on that Rs 18,000 crore instead of leaving it in interest-free CRR — and, by extension, companies that should benefit from lower interest rates on their loans.
The reduction in CRR was ostensibly to ease liquidity, but many analysts believe it may not have been really necessary for that purpose. The combination of reductions did send a signal to banks that they could, and perhaps should, lower interest rates. But the policy statement also highlighted the deteriorating current account; at the same time, inflation may be a lesser worry, but a worry that remains. The current account deficit has pushed inflation slightly into the background; at 5.4 per cent of GDP, it is clearly unsustainable. The appropriate and comfortable level is 2 per cent of GDP. Granted, the levy of an import duty on gold is likely to have a salutary effect by reducing demand amongst investors (though consumption demand for it remains strong); gold had become the second biggest import after oil in the last six months. Stable oil prices in global markets are keeping the oil import bill manageable; the value of the rupee, however, is still volatile, and the inflationary risks of a depreciating currency remain. The government will have to continue to do what it has to mitigate the twin deficits. To paraphrase the late Milton Friedman, economist and Nobel laureate, monetary policy is a string: one can pull it to rein in inflation, but one cannot push it to revive economic growth by itself.