The Policy Constant

AS MARKETS expected, the Reserve Bank of India (RBI) did not reduce its policy rate—the repo rate—on December 6th. The central bank kept its rate unchanged at 6 per cent. Importantly, the policy statement said its monetary policy stance will remain neutral. In plain words: lending rates will not be reduced on the back of growth concerns.

In recent weeks, there has been much concern about the bank’s impending decision based on the gap between India’s potential growth rate and the actual rate at which its economy has grown in the past few quarters. This gap is now negative, with observed growth below its potential. In such conditions, a rate reduction is an obvious policy response. The implementation of the Goods and Services Tax and demonetisation had imparted policy shocks to the economy, and were another factor in favour of a looser monetary policy. The bank has acted otherwise.

Three factors affected RBI’s decision. One, retail inflation touched a seven-month high in October. This was not unexpected and the central bank had warned about higher inflation in its previous policy announcement. Two, RBI surveys of household expectations of price increases over the next three months to a year had shown a hardening. People expected their general cost of living to go up. Finally, a clutch of other indications—such as rising global prices of crude oil, farm loan waivers by some states, and a roll back in excise duty and VAT on petroleum products, plus the lowering of GST rates for some items— that could result in fiscal slippages contributed to the RBI worry over inflationary pressures.

It will be wrong to say the RBI is not concerned about the country’s growth prospects. The central bank has highlighted several positive developments that point to an uptick. The improvement in India’s Ease of Doing Business ranking and its new framework to resolve insolvency and bankruptcy are expected to boost the economy.

It is a matter of debate whether a rate cut should be part of this slew of policy measures. At this juncture, it does seem to be. Inflationary pressures do need attention. From an institutional perspective, any central bank operating in an environment of sudden price spikes—and India is one such—will exercise caution in easing its monetary policy. The question is about the opportunity cost of such decisions.

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