Subbarao's win against inflation is growth's loss

There was a time when Reserve Bank of India (RBI) Governor D Subbarao would keep repeating that the wholesale price inflation rate had to fall before he could cut interest rates. Subbarao's staunch refusal to lower interest rates even annoyed the union finance ministers, be they (now President) Pranab Mukherjee or his successor P. Chidamabaram. Both felt growth could only be kick-started by reducing interest rates.  

The WPI numbers actually did start to fall, and have been falling for the last 12 to 15 months. They are down from double digits to less than 5 per cent. But interest rates have still not been reduced to the extent many would like.

The successive reductions were not enough for bankers to dole out cheap loans at a time when they have been facing lower growth and rising non-performing assets.

For Subbarao, the first hurdle in the path of reducing interest rates was replaced by a second.

Though WPI was tamed to an extent, consumer price inflation (CPI) became a big concern. It remained stubbornly high even after the fall in the WPI to 4.86 per cent in June this year. The CPI, which was at 7.65 per cent in January last year, remained at an elevated level of over 10 per cent till March. The last recorded CPI (for June) is 7.65 per cent.

The new emerging danger is on the currency front.

The depreciation of the domestic currency against the US dollar has raised fears of imported inflation seeping in through higher prices for imported crude oil, which is the biggest import item. Similarly, there is the risk of higher inflation through manufactured goods as many companies import their raw materials, plant and machinery. Higher fuel costs also get factored into the prices of goods.

Indeed, the steep fall in the rupee value to 61-plus against the US dollar last  fortnight is now the biggest stumbling block in the way of softening interest rates.

Rupee volatility reached such a level that the RBI was forced to announce a host of liquidity tightening measures a week before the first quarter monetary review scheduled for Tuesday, July 30. These measures have instantly increased the short-term interest rates and also restricted the borrowing capacity of banks. The idea was to restrict banks from taking any speculative positions in the inter-bank foreign exchange market.

The move was successful in that the monetary tightening, which made money costlier to borrow, has already reduced volatility in rupee trades. The rupee value has now recovered to 59 levels.

But bankers aren't happy. Pratip Chaudhuri, chairman of India's largest bank State Bank of India, lambasted the RBI Governor last week for being not transparent while taking such measures. Chaudhuri wanted the governor to openly admit the measures have been taken to protect the falling rupee, which given Subbarao's position, he cannot do.

But for Subbarao what matters is the end result. In such a scenario, there are not many who are expecting the RBI Governor to tinker with the repo rate on Tuesday. It is currently at 7.25 per cent. The cash reserve ratio is also expected to remain at 4 per cent.

This monetary review could be Subbarao's last if he doesn't get the extension (he is expected to retire in September.) but the battle against inflation he has surely won. The casualty, however, has been growth, which plunged to 5 per cent last year.

There is a danger to growth if the rupee continues to slide against the dollar in the future and if the RBI were to stay away from reducing interest rates.  There are experts who say RBI should reduce interest rates to spur growth. The reasoning is if growth comes back, the FIIs or FDI will also return, which will ultimately help in strengthening the rupee.

Subbarao will surely say achieving any result from a monetary policy in an  integrated global world today is easier said than done.