Read Editorial – RBI monetary policy: Growth, with caveats

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The central bank was not expected to tinker (attempt to repair or improve something in a casual or desultory way) with key policy rates in its first monetary policy review of 2017-18 unveiled (show or announce publicly for the first time) on Thursday, following its decision to shift from an accommodative (helpful in bringing about a harmonious adaptation) to a neutral monetary policy stance (a person’s posture) in February. The Monetary Policy Committee chaired by Reserve Bank of India Governor Urjit Patel has, in fact, decided to raise the rate at which the central bank borrows funds from banks (the reverse repo rate) by 25 basis points, from 5.75% to 6%, while leaving other policy rates untouched.

This marginal change is aimed at sucking out from the system excess liquidity that remains a lingering (lasting for a long time or slow to end) concern, despite coming off its peak in the aftermath (the consequences or after-effects of a significant unpleasant event) of the demonetisation exercise. The RBI has also proposed a new liquidity management tool that awaits government approval, making the draining of surplus (more than what is needed or used; excess) liquidity a critical priority all through this year.

The efficacy (the ability to produce a desired or intended result) of the RBI’s liquidity management toolkit will impinge (have an effect, especially a negative one) on another key concern: inflation (a general increase in prices and fall in the purchasing value of money), which is expected to climb to 5% by the second half of this fiscal (relating to government revenue, especially taxes). The RBI says achieving the stated target of 4% inflation even next year could be challenging, with no “lucky disinflationary forces” expected, such as benign (gentle and kind) commodity and oil prices. It has also pointed to a one-time upside risk to inflation with the implementation of the Goods and Services Tax.

The RBI is quite optimistic (hopeful and confident about the future) about an uptick in the economy this year, projecting 7.4% growth in Gross Value-Added, compared to 6.7% in 2016-17. Along with improved prospects for the world economy a rebound in discretionary (optional; not compulsory)  consumer spending at home is likely, in line with the “pace of remonetisation (restoring to the status of legal tender)” and investment demand on account of lowered interest rates. While the government may take heart from the higher growth projection, it must pay equal heed (pay attention to; take notice of) to Mr. Patel’s plain speak on four key issues.

First, the need to urgently resolve the surge of bad loans on bank books, for which the RBI will unveil a new Prompt Corrective Action framework by the middle of this month. Without this, a virtuous (having or showing high moral standards) cycle of healthy credit growth necessary for investment and job creation will remain elusive (difficult to find, catch, or achieve). Second, the RBI has reminded the government there will be “clearly more demand for capital” in the coming days. The government’s allocation of Rs.10,000 crore to recapitalise public sector banks is obviously inadequate (lacking the quality or quantity required; insufficient for a purpose).

Third, while banks have reduced lending rates, the RBI has pointed out there is room for more cuts if rates on small savings schemes are corrected. Though a formula-based rate was adopted to set these rates last April, small savings schemes still deliver 61-95 basis points higher returns than what they should if the formula is followed, as per the RBI. Most important, the government must not ignore Mr Patel’s categorical call to eschew (have nothing to do with) loan waivers (neglect) of the kind just announced in Uttar Pradesh. This, he warned, would crowd out private investments and dent (a reduction in amount or size) the nation’s balance sheet.

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