In a surprise move, the RBI on Tuesday pruned the key policy rate by 50 bps to 8%. RBI governor Duvvuri Subbarao told Shobhana Subramanian that he expects monetary transmission to take place despite sluggish deposit growth, because cuts in cash reserve ratio have brought down the cost of funds for banks.
Given the government?s policy inaction and the state of politics, do you believe that a 50 bps cut at this juncture was prudent and will revive investment?
We have to take everything as given. We have taken the Budget numbers as given and the commitments that will be fulfilled such as the capping of subsidies and the adjustment of administered prices. As regards our action, we looked at headline inflation, which is down to 6.9% while core inflation has dropped to below 5%.
In October, it was closer to 8%. In fact, several analysts have asked us how we justify not easing policy.
Perhaps the RBI could have waited for the government to deliver on some commitments, like the fuel price increases and the monsoon before opting for a 50 basis points cut?
Well, there could be several permutations; we took this action expecting that this is one of the unknowns in the investment calculation. We believe inflation should be range-bound and trend towards 6.5% by March 2013 although there are risk factors including the administered price adjustment, fiscal deficit, monsoon, rupee depreciation and oil prices. It?s difficult to be confident about the inflation trajectory.
Do you see monetary transmission even though the growth in deposits has been so sluggish? How will the cost of funds for banks come down?
Yes, I believe some transmission will happen because the CRR cuts have reduced the funding costs for banks and the existence of the MSF itself should be a source of comfort.
The RBI has said pricing power is reduced so that any hike in administered prices will not have such a big impact on inflation?
We have some numbers about how much every $10 increase in prices translates into inflation and how much into growth. But I don?t think the relationship is very robust or linear. So, I have read it the way you have read it, which is that since pricing power is constrained, input prices may not be passed on to output prices and therefore, the probability of adjusted administered prices translating into generalised inflation is low.
A rate cut alone will not kickstart investment. Can anything else be done?
Not by the RBI. It cannot be done by brinkmanship between the monetary policy and the fiscal policy or between RBI and the government. We expect adjustment on administered prices and easing of supply constraints. But I do hope there will be a revival of sentiment and perhaps those who have clearances will go ahead with projects.
What does the RBI have to say on the government allowing some sectors to access ECBs?
It is a concern and we must reduce the current account deficit. That?s a matter of constant dialogue between the government and the RBI. But public policy is balancing between macro concerns and micro compulsions.
Given the sluggish growth in deposits, how do you see non-food credit growing at 17%?
Well, that?s our best judgment based on money elasticity.
