The smart money is on RBI maintaining the status quo in next week?s monetary policy. But that wouldn?t be the smartest thing to do for RBI. There should be a policy rate cut. Indeed, if one went by RBI?s argument during the time it tightened monetary policy, rate cuts would be certain. But the goalpost would seem to have shifted. All the time when WPI was going up, monetary policy took this year-on-year, seasonally unadjusted price index as the gospel and hiked policy rates; bank lending rates faithfully followed. Now that the same WPI is in negative territory for six weeks running, doubts have been raised about its efficacy as an inflation indicator. Of course, WPI is a bad indicator. But there?s some explaining to do why a rising WPI is a monetary policy guideline, but a falling one isn?t. The good argument for a rate cut, just as the good argument against rate hikes when RBI overtightened monetary policy, doesn?t depend on WPI. Seasonally-adjusted inflation shows a sharp fall and allays worries about a sharp jump any time soon. By the way, the new favourite inflation index, the CPI, is also down a bit. If food prices keep rising because of an uneven monsoon, using domestic stock and imports, not high interest rates, should be the response. Some primary commodities may still show a sharp price rise?but should monetary policy be geared to keep prices of some primary articles down? This shows RBI doesn?t need to be anxious just now about staying ahead of the curve on inflation management. Plus, surely there needs to be a sharp policy distinction between demand-driven and lack-of-supply-driven inflation?
The fact that bank lending rates haven?t proportionately responded to RBI nudges since October means that RBI should try to be more radical, provided there?s no fear of demand-driven inflation in the near future. There isn?t any such fear. Also, and RBI must think about this, not just bank lending rates, but a host of other crucial rates?for example, those on corporate debt?depends on RBI?s policy rates. The other argument against a rate cut rests on proof of recovery. Yes, there?s proof. The June year-on-year growth figure for the core sector?six industries that account for almost 27% of the weight in IIP?is 6.5%, the highest since February 2007. IIP figures are improving as well. But if one looks at seasonally-adjusted data for capital goods, there?s some evidence that investment has not recovered. Government expenditure, including the Pay Commission award, has helped the economy, but the key is private investment. And in that context, the price of credit in real terms remaining high makes no sense. So, a rate cut next Tuesday is logical. What will also be logical is for RBI to not make heavy declarations of intent on withdrawing liquidity some time in the future. That may have to be done at some point of time. But this is not the time to talk about that time.
