Bark sharper than the bite

Reserve Bank of India’s monetary policy decision on Jan. 25th was disappointing and lame. It should have raised rates by 25 basis points. I had mentioned as much in my MINT column. Nonetheless, RBI’s third quarter review of monetary policy is well worth a read. Following paragraphs caught my attention:

The combined risks from inflation, the CAD and fiscal situation contribute to an increase in uncertainty about economic stability that consumers and investors will have to deal with. To the extent that this deters consumption and investment decisions, growth may be impacted. While slower growth may contribute to some dampening of inflation and a narrowing of the CAD, it can also have significant impact on capital inflows, asset prices and fiscal consolidation, thereby aggravating some of the risks that have already been identified. [Paragraph 41 – vi]

While energy prices are driven by global developments, the food price scenario is primarily a reflection of persistent structural constraints in the domestic agricultural sector. …Unless meaningful output enhancing measures are taken, the risks of food inflation becoming entrenched loom large and threaten both the sustainability of the current growth momentum and the realisation of its benefits by a large number of households. [Paragraph 45]

If the Government is able to commit more resources to capital expenditure, it will help deal with some of the bottlenecks that contribute to supply-side inflationary pressures. With reference to revenue expenditure, while large and diffused subsidies may contribute in the short term to keeping supply-side inflationary pressures in check, they may more than offset this benefit by adding to aggregate demand. [Paragraph 46]

The full document is here. May be, this is a dynamic link and might be replaced when the next quarter document arrives.

In a note to clients, Jahangir Aziz of J.P. Morgan concluded as follows:

RBI’s concern that in the presence of a significant fiscal deficit and high inflation, the large current account deficit could severely deter investor interest in India thereby tarnishing medium-term growth prospects is a fair warning. However, whether or not this risk materializes depends to a very large extent on monetary and fiscal policy actions taken in the near term. A stronger action today by the RBI could have significantly reduced this risk.

Amen to that last sentence.

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