Government needs RB I to loosen up (FE EDITORIAL)

T HE government tabledthemid-year review of the economy in Par its liament on Tuesday. By standards of government reports, the re view is quite honest. The most honest admission is that the government will not meet its fiscal targets this year. This was widely known and not news. But the government saying it in Parliament still matters. Worries about this are being tempered by the need for economic stimuli. This is a debate that will go into next year. What one isn’t sure of is whether the government has learnt the lesson: build a surplus or lower deficit in good times. The growth projection of 7% seems honest and reasonable enough, even if it is at the upper end of the forecasts made by independent analysts. Importantly, the government has taken note of the worldwide decline in commodity prices and has predicted that inflation will return to normal levels by March. But the review could have avoided making the useless distinction between being directly and indirectly hit by the global financial crisis.

Policy prescriptions to be gleaned from the review? All macroecnomic data calls for further lowering of interest rates. If growth is slowing, inflation is heading towards normal and fiscal policy is a constraint, then monetary policy must step in big time. Also, if banks and other corporate institutions are not facing insolvency or big bad asset problems, but are affected instead by factors like confidence and risk-averseness, lowering of rates substantially may stimulate both borrowing and lending. According to a report in The Indian Express on Tuesday, RBI, in the best conservative tradition of central banks, is reluctant to lower rates. Even the earlier cut in the repo rate to 6.5% and reverse repo to 5% earlier in December were apparently difficult decisions. The government is pressing RBI to cut rates more steeply, by 200 basis points or so. Current evidence suggests that banks continue to place a large amount of money with RBI as reverse repo remains attractive. This attraction should go. The economy desperately needs a kickstart and the interest rate policy has enough room for manouevre. RBI’s dithering in late 2008 could come at a high cost to the economy in 2009.