Why the RBI governor restrained himself from taking the lead in slashing lending rates

The Monetary Policy Committee (MPC) headed by RBI governor Urjit Patel seems to have played safe while dealing with key rates notwithstanding its projections about softening inflation expectations during this fiscal. The big question is why the RBI governor restrained himself from taking the lead in slashing lending rates. The majority of members seem to have preferred treading a more conservative path rather than experimenting with the Indian money system tools given the complete flexibility and authority that the august team enjoyed. Not many innovations have been made in dealing with the monetary system and the economy at the macro level.

While repo rates were left unchanged at 6 per cent for the fourth time in a row, reverse repo at 5.75 per cent was left untouched. The multi-member policy panel, however, pulled down the retail inflation expectations to 4.5 per cent from the earlier 5.6 per cent. The MPC also reiterated its commitment to keep the inflation at 4 per cent. By keeping the rates unchanged, RBI shifted the onerous responsibility of reviving the investment climate and consequently putting the economy on a high growth trajectory to the government.

The government should not have been left to fend for itself while giving a big push to economic activity by making use of green shoots and reported improvement in credit off-take. If the economy were to fire on all cylinders, then both the RBI and the Narendra Modi government will have to work in tandem in managing the currency markets and exercise all policy options at their command. Only positive from the policy review was the recognition and expectations of a higher economic growth at 7.4 per cent from last financial year’s subdued 6.6 per cent and lower than expected inflation. This will definitely enhance the confidence of the Modi government that is poised to take on the (dis)united opposition in the next round of assembly polls and Lok Sabha elections.

The moderation in vegetable prices seems to be a big plus for the government that is neck deep in work in its efforts to put the economy back on track after the November 2016 demonetisation of high value currency notes and making GST a reality from July 2017.

While these factors portend a very positive outlook, RBI seems to have kept its sense of balance intact. It also cautioned the government on the adverse impact of two key global developments. Firming up of global crude prices that have already touched $70 per barrel and trade wars between China and US have easily been identified as two defining factors to ensuring low inflation and possible pull down in demand for goods and services internationally. India may have very few instruments to build firewalls to negate the impact of these issues.

Further, the decision to accept most recommendations of the Seventh Pay Commission and 50 per cent margin on all costs allowed for farmers while announcing minimum support prices would contribute to inflationary pressures. In an election year, given that the government tends to front-end spending for speeding up projects and creating consumption demand, there is every reason for a spurt in inflation and prices.

Since, the monetary policy committee was meeting for the first time in this financial year, the cautious stand would send out signals as to what is in store for the economy going forward. From the ruling party’s point of view, getting the economy on the right path to recovery is very important for being able to encash politically in the next round of elections. This is particularly a key issue given the all out attack by opposition parties on the alleged mismanagement of the economy, huge banking scandals that have come into the open and a critically for the BJP, a feeling in its core constituency, i.e. the middle class voters, that they have been let down.