On the face of it, the Monetary Policy Committee’s decision to lower the repo rate by 25 basis points makes perfect sense. After all, inflation has been persistently below the RBI’s forecast. The weighted average call rate has been below the repo rate for most days in January and four out of six days in February.
Growth is decelerating across the world, US interest rate hikes appear to be on hold and crude prices have lost their zeal to leap skyward. Fiscal slippage has been announced to be minimal for the Centre. While the December statement had detected increased capacity utilisation and probable efforts to increase capacity, momentum has weakened since then in industry and services, with agriculture alone showing a pick-up. So, there would appear to be every reason for a rate cut, quite unrelated to the perceived readiness of the new RBI governor to read the government’s mind. But, yet, there is need for caution.
Without reservation, we welcome the policy stance shifting from calibrated tightening to neutral. However, there are two reasons to step gingerly around a rate cut.
One is the fiscal deficit. The Centre’s fiscal deficit has been pegged at 3.4% of GDP. But this figure does not include Extra Budgetary Resources (borrowings that are serviced entirely out of government resources). This accounting fudge has to be removed and a transparency instituted in measuring the government’s debt and incremental debt. The state governments are supposed to work under a tight fiscal constraint, as they cannot borrow money without the Centre’s consent. However, reports indicate that the states have embarked on a spree of sops, in addition to loan waivers.
The small savings that states have been shunning present themselves as a form of borrowing on tap. If the aggregate fiscal deficit of the Centre and the states goes up when investment revives, we will see inflation.
The other reason is political economy. Farm distress cannot be resolved without ending farm price repression.
While the resultant price rises must be looked through, their second-order effects will have to be curbed.
This piece appeared as an editorial opinion in the print edition of The Economic Times.
via Cautious welcome for repo rate cut