Will RBI continue what the government has started?

Rate cuts versus inflation? Like his opposite numbers in central banks around the world, RBI governor Dr. Subbarao knows the fine art of balancing. However, when the central bank meets on Monday (September 17) to review its monetary policy, industry, policymakers and the common man will all be asking one question: will Subbarao continue what Prime Minister Manmohan Singh started?

Until now, the RBI placed the onus of pulling the economy out of its slumber on the government. This week, Dr Singh put the ball back in the RBI’s court.

After facing months of scathing criticism from media and financial institutions, both in India and abroad, on his government’s policy paralysis, Dr Singh braved the might of UPA allies and the Opposition to announce a series of big-bang reforms, beginning with an increase in diesel prices followed by allowing foreign direct investment (FDI) in multi-brand retail and power exchanges as well as relaxing the norms on FDI in aviation and broadcasting...

... And corporate India applauded.

Anand Mahindra, chairman and managing director at Mahindra & Mahindra, said India had gone “from a famine to a feast”.

Venugopal Dhoot, chairman and managing director at Videocon, said: “The sleeping tiger is now out of the cage. So, 2012 will show the way for the country. Opposition will be sensible and recognize that this is good for the country… these things are required for (a) democracy.”

Mohandas Pai, Member of  Manipal Global Education Services, said “Yeh dil maange more.”

The parched stock markets, after a long dry spell of dips on panicky withdrawal of funds by foreign institutional investors, soared to close at a 14-month high on Friday, despite August inflation numbers coming in at 7.55 per cent against analyst estimates of 7 per cent.

Hopes of a rate cut from the central bank rose when soon after the price of diesel was increased, Dr C. Rangarajan, chairman of the Prime Minister’s Economic Advisory Council, said the price hike would help the RBI cut rates.

Already, Subbarao’s counterparts in the US Federal Reserve and European Central Bank have raised the bar by announcing easing measures. Early this month, the European Central Bank agreed to a new unlimited bond-purchase programme to lower borrowing costs for the struggling Eurozone. A week later, the US central bank launched a fresh round of bond-buying to stimulate the economy, purchasing $40 billion of mortgage debt each month until the outlook for jobs has improved substantially.

However, for the RBI, shrugging off the inflation numbers will not be that easy.

Earlier, Dr Subbarao had said reining in inflation is the central bank’s priority and had to fall further, dismissing criticism of the bank's hawkish policy stance.

Since cutting its main interest rate in April by a bigger-than-expected 50 basis points to 8 per cent, the RBI has stayed on hold, drawing complaints that high rates are burdening consumers and slowing growth.

Cutting interest rates, however, may only support growth in the short term, while high and persistent inflation will harm the economy longer term, Dr Subbarao said.

Much of the criticism of the bank's policy was coming from a "very articulate" growth lobby in India that includes companies, and said the central bank must also consider other constituents, including the poor, the governor added.

For the common man, inflation means an increase in price of essential goods and commodities. Managing inflation, therefore, is of prime importance in any economy.

“With the price hike, the headline will definitely go up next month (September),” said A. Prasanna, senior vice-president at ICICI Securities, after the numbers for August were announced.

“I would like to see RBI cut the rate, the benefit in cutting the rate will have (a) more positive effect on containing inflation. I'm in favor of reduction of rates, CRR,” said Adi Godrej, chairman of the Godrej Group.

Inflation has averaged a little over 7 per cent this year and although it remains above the RBI's perceived comfort level of 5 per cent, it is lower than the 9.52 per cent average through 2010 and 2011.

In a Reuters snap poll of 18 economists, all but two expect that central bank to leave its policy repo rate unchanged at 8 per cent, in line with a poll conducted earlier this month.

The median estimate for the repo rate at end of 2012 was 7.75 per cent, unchanged from the previous poll.

The RBI has held the policy repo rate steady since cutting it by 50 basis points in April and has said further cuts depend in part on the government's steps to contain the fiscal deficit.

The diesel price increase is too small a step by itself to provide the required comfort to the RBI, economists said.

So, if the last week was the government's, will this week be the RBI's?

With inputs from Reuters