'Monetary policy different from popularity contest'

The Reserve Bank of India (RBI) once again thumbed its nose at consensus street expectations by refusing to lower any of the benchmarks rates. While the markets are swinging from derision to delusion, RBI has to be given credit for being objective in the face of a growing clamour for rate cuts from both Dalal Street and New Delhi. Conducting an effective monetary policy is different from running a popularity contest and by denying the punch bowl for the party to begin, RBI in chorus with the global rating agencies, has been expressing its concerns sotto voce and fortissimo.

Inflation, especially on the consumer side, has been out of bounds by printing in the double digits consistently for close to three years now stoking public angst. The silver lining however is the moderation in the core inflation which is more critical for monetary policy. The policy rates have not exceeded the previous cyclical highs experienced in the first half of 2008 despite higher headline inflation as the RBI exercised restraint in not reacting to rampaging food inflation.

The deposit rates however are more sensitive to the CPI as they have to compete with small savings instruments and corporate debt. If the CPI does not moderate, the deposit rates will be sticky on the downside which will defeat the purpose of any rate cut as the same cannot be passed on by banks which is being witnessed currently. The food inflation just got a boost as the centre approved a 16 per cent to 54 per cent increase in maximum support price (MSP) for the kharif harvest. Persistent increases in MSP over the last eight years have started manifesting in food inflation entering the corporate wage structure. While there is growing consensus among economists that much of the problems plaguing us are on the supply side, empirical data does not bear this out. A classic supply crunch should lead to producers operating at full capacity making super normal profits. On the contrary, operating margins are under pressure owing to wage increases and lower pricing power.

High food inflation when FCI godowns are overflowing with grains is a good example of the contradiction. Similarly Index of Industrial Production (IIP) cannot be close to decade low in the face of supply bottlenecks. It seems more likely to be a case of cost push inflation lowering the overall purchasing power of the consuming class combined with poor investor sentiment in the wake of some debatable policy actions which have stalled the investment capex cycle. Corporates must appreciate the complexity of the challenges confronting the polity. Progressive action can yield results. The issues for many corporates are navigating the lower pricing power and mustering resources and conviction to invest for the future. In both cases, sharp focus on core business and effective cost management would improve things.

Interest rates are elevated but not high enough to stifle competitive businesses. It might be an opportunity to develop niches to specialise in or to build competencies to ride high on the next wave. History is replete with instances of adverse economic conditions forcing businesses to rethink, re-strategise and reorient to emerge stronger. Meanwhile RBI will cut rates decisively when it’s not threatened by the prospect of rising inflation and inflationary expectations which might be 2 to 3 quarters away. Investment cycle will not always respond like a Pavlov’s dog to monetary stimulus. So, Delhi must kick start growth by improving governance aiding investor sentiment, independent of monetary actions. It means getting some legislation such as the land acquisition act and goods and services tax (GST) off the ground and devising ways to gradually lower subsidies and improve revenue.

The government is aware of the way forward but is hesitant to act as Jean Claude Junker, head of the Euro Zone Finance Ministers once observed , “We know what to do; we just don’t know how to get elected after we do it.”
(The author is CMD, Angel Broking)