Last week the government cut fuel subsidies and eased restrictions on foreign investors. In return for this good behaviour, some people said, the Reserve Bank of India (RBI) would quickly cut interest rates. Instead, it held them on Monday. But the hopes were irrational, and the RBI was sensible to dash them.
The inflation rate surprisingly accelerated to 7.6 percent in August. That made it irresponsible for Governor D Subbarao to follow up on April's half-percentage-point cut in the policy rate. Besides, the current-account deficit, which ballooned to a record 4.2 percent of GDP in the last financial year, is unlikely to narrow to a more sustainable level soon.
The rupee has fallen 14 percent against the U.S. dollar in the past year, but that is not closing the trade gap. Exports are sputtering and the nation's energy import bill is likely to remain high. If the U.S. Federal Reserve's new quantitative easing pushes up the price of oil, the bill will rise, perhaps in the face of lacklustre global growth.
In any case, while a rate cut might make capital less expensive, there are other restraints on the publicly traded companies controlled by local entrepreneurs, the source of between 50 and 70 percent of capital expenditure between financial years 2005 and 2008, according to Jefferies' analyst Nilesh Jasani. Most notably, too many of them are already neck deep in debt.
The central bank isn't ignoring the government's efforts. Governor Subbarao said monetary policy will be used to "reinforce" pro-growth government policies and acknowledged that recent actions have paved the way for "a more favourable growth-inflation dynamic."
The next monetary policy announcement comes in six weeks. Just how much room the RBI will have by then is unclear. What is certain is that lower diesel subsidies translate into higher transportation costs for manufacturers. Inflation could perk up in coming weeks. The central bank will need to stay cautious.
- The RBI left interest rates unchanged on September 17 but cut the cash reserve ratio for banks, disappointing market hopes that it would follow up the government's unexpected spate of bold reform measures by reducing borrowing