Inflation vs growth: The perfect dilemma for RBI on July 31

Updated: Monday, July 30, 2012, 8:31 [IST]

In all of his monetary policies delivered so far, the most tricky one for RBI Governor Subbarao is likely to be the one to be delivered on July 31. While the broad consensus indicates that the Governor is likely to keep policy rates on hold, it's unlikely to be that easy.

GDP growth in Q4 2012 has hit a nine year low, while inflation continues to be elevated levels. The governor has to strike a balance between growth and inflation, though in the past he has already hinted at sacrificing growth to tame inflation. The industry has been hankering for rate cuts in view of the slowdown in the economy, with pressure to cut rates coming even from the government.

This time the problem for Governor Subbarao is that Monsoon has also played truant. This is likely to give rise to escalation in food prices which is likely to push the WPI inflation number up further.

This means that it would not be an appropriate time for the RBI Governor to go ahead and cut rates on July 31. In all likelihood he might not do so, though one must say that inflation has softened a bit, but deficient monsoons has given rise to fresh worries. Also, the RBI had cut repo rates by 50 basis points in April, indicating that the repo rate cut then was front loaded.

While the indications are that the RBI would leave repo rates unchanged, there is a possibility of the Central Bank going ahead and cutting the cash reserve ratio requirements (CRR) for banks.

"We expect a 0.5 percentage point reduction in CRR (the percentage of deposits that banks park with the RBI) to ease money supply. Also, this will have better effect on monetary transmission than a reduction in the short-term lending rate," SBI Chairman Pratip Chaudhuri told reporters after announcing the successful conclusion of a USD 1.25 billion overseas bond sale.

It's likely that the RBI might cut the CRR, which should also ease liquidity conditions in the banking sector and also help bring down interest rates in the economy.

In any case, one will have to wait for July 31 to see what the RBI does and also what the Governor says. A dovish stance would augur well for the industry and stock markets.

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