Surprise fall in CAD, inflation needed for further rate cuts

Written by fe Bureau | Mumbai | Updated: Jan 30 2013, 07:43am hrs
RBI governor D Subbarao clearly does not want to dole out rate cuts easily and wants inflation and current account deficit to surprise on the downside. Indeed, RBI may not cut rates if the fall in inflation and CAD follow on expected lines.

If inflation and CAD moderate further, we will have more room for monetary easing, but if they go along expected lines, the space for monetary easing is limited, Subbarao told reporters. Subbarao refrained from giving a specific number that the RBI was considering in its policy calculations, but said a CAD of 2.5% of the GDP was sustainable and anything above it was a cause for concern.

The central bank's macroeconomic report had said that the CAD is hampering rate cuts. Subbarao said that despite a high CAD, which in theory calls for monetary tightening, the RBI went ahead and slashed rates owing to moderation in growth.

Besides the CAD, the governor listed several upside risks to inflation, such as global commodity prices, food inflation, rising wages and the weak investment climate that hinder rate cuts.

A weak investment climate has supply-side implications and must be addressed, he said. Citing several non-monetary measures needed to revive investment, he hoped that the RBI's rate cut will contribute in lifting investment climate.

We have to encourage investment by reducing lending rates, we have to discourage consumption and improve saving and reduce the CAD, he said.

Subbarao said food inflation continues to be elevated and remains a cause for concern. Persistent food inflation could entrench inflationary expectations and would, in turn, force monetary policy to respond to such expectations, he said.