The central message of Reserve Bank of India Governor Raghuram Rajan’s > latest decision to leave interest rates unchanged, and stress that the monetary stance remains “accommodative”, is that neither an economic recovery nor inflation trends are entrenched enough at the moment for more decisive action. That the signs are far from reassuring on both the key fronts that inform the central bank’s policy rationale is abundantly evident from the data on hand. External demand continues to remain weak — with global growth and trade becalmed by an anaemic Euro area, a slowing China and a U.S. economy coping with an accumulation of inventory, year-low consumer confidence and a strengthening dollar. On the domestic front, while early results from the RBI’s survey of order books, inventories and capacity utilisation point to an uptick in new manufacturing orders in the second quarter, other indicators, especially from the sizeable rural economy, are far from reassuring. Consumption demand in the villages and smaller towns in agrarian heartlands has been weakened by two consecutive deficient monsoons, and the overall outlook for agricultural growth, as a result of deficient rains, appears at best moderate. The latest Nikkei’s Manufacturing Purchasing Managers’ Index, compiled by Markit, independently buttresses the central bank’s concern over the sustainability of the recovery as it shows demand and output continued to soften in November to damp manufacturing growth to the slowest pace in 25 months.
Data on the prices front is equally unnerving. Retail inflation as measured by the consumer price index accelerated for the third successive month in October, pushed up by a sharp increase in food costs. Initial indications of rabi sowing, coupled with low reservoir levels, also squarely lay the onus on astute supply management by the government to help minimise any shortfall in winter crop output and the resultant risk to prices. And taking a benign oil price environment for granted, given the potential for geopolitical shocks from the volatile Middle East, has its own inherent hazards. More significantly, the RBI has for the moment opted to trust the government’s commitment to its fiscal consolidation goals in its calculus of the inflationary impact of the > Seventh Pay Commission’s proposals. Voluntary budgetary restraint, the central bank believes, will offset the impact on aggregate demand from higher wages and rents. That this assumption is only partly predicated on good faith is evident in the comment in the policy statement that the implementation of the pay panel’s recommendations will “be a factor in the Reserve Bank’s future deliberations”. Dr. Rajan has his task cut out as he focusses on unclogging the monetary transmission pipeline at banks. With only about half of the 125 basis points cut in the policy rate > conveyed to borrowers , the RBI is racing to ensure that a clean-up of lenders’ balance sheets can help free up funds toward productive credit flows. For now though, it will be a vigilant watch at the RBI.
