Only yesterday, the finance secretary, called reporters to North Block to emphasise that the Indian Financial Code, revised and updated, did not mean to curtail the Reserve Bank’s powers for setting monetary policy. The IFC had suggested creation of a panel to set interest rates and take away the RBI governor’s veto powers to choose the rate. Along with all that the government had also suggested the need for a rate cut now.

In fact, the finance minister and all others have been suggesting that a rate cut is so very urgent for the economy to revive. But it all seemed to have fallen on RBI’s deaf ears. In fact, even now RBI does not seem to have taken to using any hearing aid. The current round of monetary policy has to be seen against this perspective of an undercurrent of a rift, once again, between the finance ministry and the monetary authority.

In fact, in the midst of a monsoon when the spread of rains still remain somewhat unclear and its effect on the farm economy uncertain, Reserve bank could not have taken a very decisive move either way. It has not raised the rates, despite the fact that prices have shown some rising trend once again. Nor has it cut rates, as demanded by government and industry interminably.

From a detailed dreading of the RBI statement , it looks as though the biggest factor holding the central bank from ushering in some further accommodative stance is the potential inflation in the economy. The RBI has underlined the “most worrisome is the sustained hardening of inflation excluding food and fuel”.

RBI review expressing its caution, pointed out several factors which bears some examination. Its policy stance appears to have been taken on basis of four factors: 1. Banks have yet to fully transmit its earlier rate cuts, banks transmitted 30 bps of its 75 bps cuts so far; 2. Watching the supply side food management and full impact of monsoon; 3. Government efforts to unclog supply side constraints like land, power; 4. Global developments like US Fed rate hike.

Commercial banks have not been forthcoming introducing rate cuts as a follow-up of RBI moves. Even when RBI introduced cuts in rates, banks have not promptly come with similar lending rate cuts. What then is the justification of a cut by the central bank. The policy change thus fails to get transmitted.

The banks on their part have pointed out the structural problem with deposit rates. If a good part of their funds are from long dated fixed deposits, then rate cut can cut away banks’ profitability. The banks have to wait until their deposit rates also get adjusted. They should be given that time to adjust.

Secondly, their experience with bad debts also weigh. Even when having surplus funds, banks have tended to seek the easy option. They put money into government securities and do treasury operations to earn money. Instead, they could have increased their lending with lower rates. But the fear of incurring more bad debts do have a bearing on banks increasing their loan portfolio. So then, the banks need to change their modus operandi as well.

As for the current inflation trends and the dynamics of inflation, these are none too reassuring. The latest inflation figures increasingly show a broader kind of inflation. While the past few months show inflation pressure across the board, with crude prices coming down, monsoon not being such a disaster as feared earlier and large food grains stocks which can cushion any increase in basic food grains prices, the chances are more than in the coming months, price rise should moderate.

RBI itself sets its inflation rate at 6% which is by and large on its targeted path. So RBI could have been les pessimistic in its inflation projections and risk a little more to introduce some rate cut. This is all the more warranted since RBI growth projection remain anchored at 7.6% as previously.

RBI has noted that several sectors of the economy are not doing too well. Investment has not picked up as measured by new projects. Capacity utilisation remains flat and therefore fresh investment in capacity creation will be sluggish. Consumption demand is also not rising as revealed in the sales figures of interest sensitive sectors like housing or car sales. RBI notices these disabilities in its policy statement. And yet, it refuses to step in with corrective measures.

Unlike the RBI, most other major central banks are proactive and pushing for monetary measures to buck up their economies. Quantitative easing was started when conventional monetary policy tools were blunted with interest rate remaining at zero. This was taken up subsequently from US Fed. Now, Bank of Japan and European Central Bank are in the midst of massive easing programs to give boost to demand and growth. So then, why is RBI so conservative in its approach.

Could it be that hammered by the government and pestered by industry, RBI is bent on asserting its independence. Is it pursuing a policy path to demonstrate that it is the supreme authority in deciding the rates. Differences between the central bank and government are not unknown. In fact, these are normal. But maybe, the government is queering its pitch by its efforts to somewhat pushing the central bank to a corner. Almost by bringing a new legislation. If there is any sense, they should mend. (IPA Service)