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BW Businessworld

Is RBI Missing The Big Picture?

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India Inc today slammed RBI's 'inflation centric policy' to keep interest rates  unchanged, saying the central bank has missed the bigger picture at a time 'when millions of  livelihoods are under threat due to declining GDP growth'.

The inevitable slump of India's rating towards junk status seems to continue with credit rating agency Fitch cutting its India outlook to negative on Monday, the second agency to do so after S&P in April.

"India is in this deep crisis due to the lack of proper governance," said A. Mahendran, managing director at Godrej Consumer Products Ltd. "What happened today is extremely disappointing. We needed the central bank to act because of the current condition of the economy."

"It is to the central bank's credit that it managed to stand up to the pressure from the government and businesses, and remains justifiably concerned about inflation," Rajeev Malik, an economist at CLSA in Singapore, said in a client note.

Asserting that easing monetary policy could worsen inflationary pressures, the Reserve Bank of India (RBI), on Monday, kept the indicative short-term policy rate (Repo rate) and the Cash Reserve Ratio (CRR) unchanged. While doing so, the apex bank has ignored widespread demand and expectations for a rate cut to revive growth.

The Reserve Bank of India (RBI) defied widespread calls on Monday to revive the flagging economy with cuts in interest rates and cash reserve minimums at banks, putting the onus on a fractious coalition government to pull the country out of crisis.

The RBI left its policy repo rate at 8 per cent and the cash reserve ratio at 4.75 per cent, saying a rate cut now could "exacerbate" the country's inflation, the highest among industrialised or BRIC nations.

A cut in interest rates would not have kick-started the investment cycle that will revive GDP growth, but would have pushed the consumption cycle, which had shown some signs of moderation in the IIP. All the various attempts to control prices are also showing up in the value of the rupee, which remains weak. (Read: Inflection Point)

Industry bodies, CII, Ficci as well as PHDCCI launched scathing attack on the central bank. Due to lack of reforms, coupled with continued high interest rate policy by the RBI, the economy is headed for a long period of 'slowflation' which will bring us closer to a major crisis, Ficci said.

It was last week that global financial services firm Moody's said Indian economy is facing stagflation,  where growth is slow and inflation high, and cautioned that the Reserve Bank cannot be too aggressive in cutting interest rates.

"It needs to be understood that with a steadily declining GDP growth, millions of livelihoods are under threat and therefore, a very inflation-centric policy measure appears to have missed the bigger picture," CII Director General Chandrajit Banerjee said.

In a scathing attack to the RBI, Ficci said: "The RBI decision to not reduce the repo rate is even more difficult to understand in light of its own admission that 'the persistence of overall inflation both at the wholesale and retail levels, in the face of significant growth slowdown points to serious supply bottlenecks and sticky inflation expectations'.

Yet another global rating agency Fitch on Monday lowered India's credit rating outlook to negative, citing corruption, inadequate reforms, high inflation and slow growth as reasons for the revision. 

Reacting to the downgrade, India's chief economic adviser Kaushik Basu said "herd mentality" of ratings agencies led to Fitch's revision of India's rating outlook to negative from stable, but added that the review was not surprising. He in fact said next six months are crucial for the economy. (Read: Fitch Cuts India Outlook)

Crumbling BRIC
The RBI made clear it expects the government to do its bit to bring down inflation, which rose in May to 7.55 percent on the wholesale price index, the country's main gauge.

Many analysts argue that structural bottlenecks in the economy are the main reasons inflation in India is so high, so monetary policy can have little affect.

The RBI said on Monday that its "frontloaded" April rate cut "was based on the premise that the process of fiscal consolidation critical for inflation management would get under way, along with other supply-side initiatives."

Finance Minister Pranab Mukherjee had called for a rate cut and the chairman of State Bank of India, the country's biggest lender, had sought a 1 percentage point cut in the cash reserve ratio.

"Unless the government takes steps on fiscal adjustment, the RBI is not prepared to cut rates. Based on this document, there's unlikely to be a rate cut in July," said A. Prasanna, economist at ICICI Securities Primary Dealership in Mumbai.

The government has failed to contain its fiscal deficit by enacting reforms or slashing costly subsidies on diesel.

Opposition from partners in the ruling coalition forced India to backtrack in December on a decision to open the retail sector to foreign supermarkets, which had been aimed at bringing investment into supply chains in a country where an estimated one-third of fresh produce is wasted.

India's Credit Risk
The slump in March quarter growth to 5.3 percent was far worse than expected and sparked calls for action to lift an economy that Standard & Poor's and Fitch Ratings have threatened to cut to junk credit status.

Both rate India BBB minus, the lowest investment grade.

"Against the backdrop of persistent inflation pressures and weak public finances, there is an even greater onus on effective government policies and reforms that would ensure India can navigate the turbulent global economic and financial environment and underpin confidence in the long-run growth potential of the Indian economy," said Art Woo, a director at Fitch.

Chief economic adviser Kaushik Basu said he had expected Fitch's action because there is a "herd mentality" among ratings agencies, while Mukherjee said Fitch "has ignored the recent positive trends in the Indian economy."

April industrial output figures last week suggested little pickup in growth heading into the current quarter.

Rahul Bajoria, regional economist at Barclays in Singapore, said he expects the RBI to cut interest rates by a total of 1 percentage point in the current fiscal year, possibly starting at the central bank's next review on July 31.

"The growth weakness is such that it does call for monetary easing," he said.

Economic policymaking was cast into further uncertainty on Friday when India's ruling Congress party named Mukherjee as its nominee for the largely ceremonial post of president, ending a protracted political drama that had exposed the weakness of the coalition government.

With no obvious successor, Prime Minister Manmohan Singh, 78, is expected to take charge of finance on an interim basis.

"We are very disappointed by the lack of action from any quarter. What is happening here is that you are getting the worst of both worlds, neither getting growth or inflation down," Rajiv Kumar, secretary general of the Federation of Indian Chambers of Commerce and Industry (Ficci) told Reuters.

(With agencies)