The Reserve Bank of India's (RBI) latest quarterly review of its credit policy would have been a non-event had it not painted a graphically grim picture of near-term economic prospects. The central bank on Tuesday refused to bring down short-term interest rates citing stubborn inflation amid a slowdown. It now expects the economy will grow 6.5% this year, much slower than its earlier projection of 7.3%. Read with the bank's expectation that wholesale inflation will stay at 7% in March 2013, this will be the third year running when prices outpace incomes. Inflation in 2010-11 was 9.1%, tolerable when the economy was growing at 8.4%. In 2011-12, inflation at 8.5% was a full 2 percentage points higher than the GDP growth rate of 6.5%. What is a bigger worry, however, is that the RBI has shaved off half a percentage point from India's medium-term growth trend and now pegs it at 7.5%. An anaemic investment atmosphere at home and turbulence abroad are chipping away at the India story.
RBI governor Duvvuri Subbarao sees no point in lowering interest rates till the government begins to bridge the trade and fiscal deficits. "Financing the latter from domestic saving crowds out private investment, thus lowering growth prospects. This, in turn, deters capital inflows, making it more difficult to finance the former. Failure to narrow the twin deficits with appropriate policy actions threatens both macroeconomic stability and growth sustainability," the credit policy review states in a candid assessment of the limits to monetary intervention. Since current economic activity is not very far from the newly lowered outer limit to growth, Mr Subbarao is prudent not to risk fanning inflationary expectations by lowering policy interest rates. The Rs. 60,000 crore extra cash that will be released by banks on easier reserve requirements should ease some of the pressure for credit.
Mr Subbarao's explicit and implicit warnings are not lost on the government. Immediately after taking over the finance minister's portfolio, Prime Minister Manmohan Singh identified the ste-ps needed to restore the investment climate. Taxes will be transparent and fair for all classes of investors. Government borrowing crowding out productive investment will be curbed. Household savings will be weaned off gold for more fruitful deployment in the capital markets. The government will lower its reaction time to business proposals. And the emphasis on infrastructure spending will be renewed, which means more joint ventures with industry. Decisive action in these areas will do more to restore the animal spirits in the economy than any big-ticket reform initiative. And if Mr Singh can build a broader consensus on stalled reforms, he could pull India out of its current cycle of rising prices and slowing growth.