Indian policymakers have faced much flak over the last few years. Which is all the more reason they need to be commended when they hold their nerve and act with courage under pressure. This, in my view, is exactly what RBI did by not cutting rates at yesterday?s mid-quarter review.

Ever since Jan-March growth fell well below 6%, markets have whipped themselves into a frenzy that RBI would engage in substantial monetary loosening, which, in turn, was (incorrectly) presumed to be a panacea to all the economy?s problems. The rates markets were pricing in 125 bps of front-loaded rate cuts (at the June, July and September reviews), and the equity market actually celebrated when industrial growth printed at zero! Why? In expectation of more rate cuts! Expectedly, markets were dismayed yesterday when RBI held firm. As it turned out, RBI?s action was justified just two minutes after the announcement?when the May CPI print was released and showed that every major component of retail inflation was running in double digits (!)?conveniently lost upon markets in the midst of their disappointment.

RBI needs to be commended for not bowing to the market pressure and, if anything, raising the bar for future rate cuts. But what the central bank really deserves kudos for is articulating why they did what they did. This is not a case of ?there is too much global uncertainty and so we will wait till the next review to act?.

Instead, RBI has taken it on the chin and decided to call a spade a spade. First, it has explicitly indicated that interest rates are not at the root of the current slowdown, noting that the role of interest rates in the current growth slowdown is ?relatively small?. I had argued last week (?Get the diagnosis right?, FE, June 12, http://goo.gl/OqbLF) that real interest rates are not the problem?they are currently lower than in the mid-2000s when industry and investment were booming. RBI also made reference to this indicating that real effective lending rates are comparatively lower than the levels seen during the high-growth phase of 2003-08. Instead, the real constraint on activity is implementation on the ground: the number of projects that have started but stalled or been abandoned has doubled over the last year. Completion rates on the ground have fallen by two-thirds in the recent quarter. And none of this has to do with interest rates. Instead, the issues are well known: land acquisition, environmental clearances, regulatory uncertainty and coal linkages.

Given this, RBI correctly identified that cutting rates would do little to stimulate private investment. But would likely stimulate private consumption?exacerbating the current stagflationary growth-inflation mix. There is a larger point here: monetary easing can do little to boost potential GDP growth if the underlying supply constraints are structural. But premature monetary easing can do a lot of damage by exacerbating output gaps thereby stoking already-elevated inflation. The dismay from market participants should not be that actual growth is too low because of high interest rates. The dismay needs to be that India?s potential rate of growth has fallen sharply, because of factors largely divorced from interest rates. Which is the reason, retail core inflation is above 10% in a quarter when growth was at 5%. And that is what policymakers in Delhi need to address.

RBI also needs to be commended for underscoring that it cannot alone do all the heavy lifting and that the fisc has to play along. The 50 bps cut in April was explicitly identified as front-loading monetary easing under the assumption that corrective actions on the fisc would be taken. A quarter into the new fiscal year, there is little to show?something at the heart of Fitch downgrading India?s outlook yesterday and S&P issuing another veiled warning last week. Despite the correction in crude prices, the under-recovery on diesel is still close to R10, and there has been no traction on the disinvestment front. With FY13 growth expected to be at least a good percentage point lower than that presumed in the Budget (7.6%), actual revenue could be significantly lower than budgeted. We are setting ourselves up for a re-run of the previous fiscal unless corrective measures on subsidies are taken soon. In this environment, RBI is quite correct in making future rate cuts contingent on fiscal actions.

In another welcome development, RBI?s policy document was replete with references to both wholesale and retail inflation and headline and core inflation. In the past, perhaps too much emphasis has been placed on core inflation within the wholesale price index. Food inflation cannot be controlled by monetary policy but plays a crucial role in wage setting. Similarly, it is retail inflation that households confront and use to shape expectations, compute real returns, and engage in price and wage setting. So it?s a good sign that RBI will likely place a much greater weight on the methodologically-improved all-India CPI in monetary policy setting going forward.

All in all, the bar for rate cuts and easier monetary policy has just gone up. Future rate cuts will be contingent on a moderation of both wholesale and retail price pressures and implementation of complimentary polices by the government.

RBI has lobbed the ball back into the government?s court thereby creating a greater sense of urgency for the government to act. In the last week the government has shown remarkable acumen and courage in drumming up support for its candidate for the Presidential election. If they can demonstrate the same resolve, courage and consensus-building skills on the economic front, the light at the end of the tunnel could quickly become visible.

The author is India Economist, JP Morgan