Economic forecasting is sometimes akin to geo-political strategy where unforeseen events can influence the direction of policy in an unanticipated manner. The Reserve Bank of India's (RBI's) rather status-quoist monetary policy on Tuesday should be seen in this context. RBI governor Raghuram Rajan, as expected, did not tinker with lending rates. The central bank kept the repo rate — the rate at which the banks borrow from the central bank — unchanged at 8%, obliquely hinting that a further rise in interest rates was unlikely if inflation were to hold its current downward trend.
In September last year, shortly after taking over as RBI chief, Mr Rajan did not hesitate to say that there was no "magic wand" to solve the immediate problems afflicting the economy. His remarks were predicated on the classic monetary "trilemma": Stabilising foreign exchange rates, boosting growth and containing inflation. Six months later at least of two of these variables seem conquered: The rupee has soared sharply and inflation rates are at multi-month lows. India's currency and equity markets have hit a sweet spot, aided by a gush of dollars on the expectations of a stable investor-friendly government after the Lok Sabha polls. Besides, vegetable prices have plunged on the arrival of fresh seasonal supplies ,pushing down overall inflation rates.
Then why hasn't the central bank cut rates to spur growth — in the monetary "trilemma"? The answer lies in the detail of Mr Rajan's policy statement. There are two rather inconsistent factors that can potentially catch the economy off-guard. First, the Lok Sabha election results. A fractured mandate can trigger fears of a policy gridlock and can wipe away most of the recent gains in stock and currency markets. Second, the spectre of a failed monsoon because of a probable El Nino effect — a weather glitch marked by an abnormal warming of the eastern Pacific Ocean known to trigger weaker rains and droughts. Mr Rajan has alluded to both in no uncertain terms. Weather and politics are the two known unknowns that can strike shocks that the economy needs to be prepared to absorb.