RBI unfolds optimism amid neutral stance

The classic central bank policy measure to prevent currency depreciation is to raise the interest rates to make local assets more attractive for foreign investors stepping up inflows. Hence, at this stage, any rate cut may dampen the overseas investor sentiments

Though the mid quarter review of monetary policy announced by Reserve Bank of India (RBI) on June 17, 2013, maintained status quo in key benchmark interest rates such as repo and reverse repo, it clearly unfolded the macroeconomic conditions that warranted such a neutral stand. Having already cut repo rates by 75 basis points since Jan 2013 and 125 basis points from its peak, the move towards diminishing interest rate regime has been well announced much earlier on a robust note.

The continued drop in industrial production to 2.3 per cent and a low GDP growth of 4.8 per cent recorded in Q4 of FY13 and 5 per cent for the entire year were some more reasons to justify a rate cut, but RBI had rightly chosen to keep the rates intact perceiving the market realities and inherent risks. Despite softening of headline inflation down to 4.7 per cent in May 2013 from a high of 7.4 per cent in FY13, the retail inflation at 9.3 per cent in May 2013 continue to dither further rate cuts now.

The RBI pointed out that the risks arising out of continued depreciation of rupee by 5.8 per cent during the current fiscal, high fiscal deficit, the flight of investments of foreign Institutional Investors (FIIs), widening CAD and uneven global economic growth are some of the factors threatening the prospects of growth of the Indian economy at this point of time. The classic central bank policy measure to prevent currency depreciation is to raise the interest rates to make local assets more attractive for foreign investors stepping up inflows.

Hence, at this stage, any rate cut may dampen the overseas investor sentiments. Moreover, the Q1 always happens to be a slack phase of the economy and the impact of measures to reign in gold imports is also yet to make much impact. Hence, with not many factors supporting the economic revival, it may not be desirable to cut the interest rates but instead, RBI opted to choose a 'hold on' measure in the larger interest.

In the meantime, removal of bottlenecks in taking forward the infrastructure projects, easing of supply side constraints, improving the sentiments of investment climate and further moderation of inflation, etc., are expected to show up positive results by July when RBI goes for a quarterly review of its monetary policy. In addition, the sluggish external demand is poised to revive and stalled domestic investments are getting back into action at various points to build a better climate for growth. From the banking perspective, the lack of sectoral credit off take needs to be addressed with attractive value proposition. The offerings under SME and agriculture should induce entrepreneurs to expand and add capacity. Similarly, offer of home loans at competitive interest rates should culminate into a catalytic force to aid economic growth.

Banks can also take a cue from the RBI risk perception and build upon their internal risk management architecture to align it with the market so that the risk appetite can be improved. On the basis of positive signals emanating from RBI, banks have to be proactive in articulating their business agenda to continue to play critical role in accelerating economic growth.

Way forward, once the supply side dynamics of food inflation further eases, agriculture and manufacturing picks up pace, balance of payment situation improves and current account deficit evolves better, RBI assured to use all available instruments and measures to respond rapidly to aid economic growth. The initiatives taken by the government and RBI to improve these economic dimensions are expected to manifest a better risk climate paving way for further low interest rate regime.

This review candidly puts forth that actions are well on course to improve the various economic parameters and it is too early to apprehend a positive action right now, nevertheless pointing out very clearly the sense of optimism in near term. Banks and markets can well appreciate the unsaid positive tone of RBI to spur the economy too soon when supportive factors fall in place.

Dr K Srinivasa Rao

(The author is General Manager, Bank of Baroda, Mumbai. The views are his own)