Ball is in FM’s court

It’s a cop-out. The Reserve Bank of India’s latest credit policy review makes all the right noises about fighting inflationary expectations, but, in the end, admits that it can do little. Reason: since there is a supply side problem, monetary policy can only do so much. The key measure announced by RBI governor D Subbarao is an increase in banks’ cash reserve ratio by 0.75 per cent —  a move that will immobilise Rs36,000 crore of bank funds.

Given weak growth in non-food credit and the enormous amount of liquidity sloshing about in the system, this move will not hurt the ongoing economic recovery. But it will certainly damage banks’ profitability a bit. It will also do nothing to change inflationary expectations unless the government does something about its own profligacy. In this financial year, the government has both borrowed excessively and spent excessively, with the fiscal deficit set to exceed Rs400,000 crore, according to budget estimates.

“The reversal of monetary accommodation cannot be effective unless there is also a roll back of government borrowing,” Subbarao said.

On the other hand, the governor has sent out mixed messages of his own which cannot but confuse the financial markets. He has upped the GDP growth target to 7.5 per cent for 2009-10, but then goes on to say that he is not sure if the economic recovery is for real. According to him, the recovery is “yet to fully take hold”. His worry is that if he focuses all his attention on tackling inflation, the RBI may end up precipitating another crisis by killing off economic growth too soon. This will deter private investment and consumer spending. While this is the obvious justification for not raising interest rates at this juncture, it also means that the RBI is partially buckling under political pressure to avoid rocking the boat prematurely. Subbarao is playing along with the government’s do-nothing gameplan. The hope is that we will have a great monsoon this year, which will help douse food inflation some time in the second half of 2010-11. Hope is one thing, but if the monsoon plays truant one more time, the economy will be up the creek without a paddle. It is not a risk worth taking.

The best hope for the economy lies with finance minister Pranab Mukherjee and prime minister Manmohan Singh, both mature statesmen with a good understanding of macroeconomics. 2010 is not an election year, and if at all the government has to take harsh economic steps — like withdrawing the economic stimulus in stages or reducing some subsidies, this is the time to do it. The basic message from Subbarao is simple: over to you, Pranab. It is time for the latter to deliver.