The Monetary Policy Committee’s unanimous decision to shift the policy stance from calibrated tightening to neutral is entirely welcome. But the decision, in a split vote that saw four members of the MPC vote in favour of a 25 basis point cut in the repo rate, deserves a more cautious welcome. True, current estimates of inflation and outlook growth warrant a cut. However, the fiscal deficit is probably higher than the 3.4% of GDP estimated for the Centre and the combined fiscal deficit of the Centre and the states could go up further, as more and more states join the sops bandwagon. When private investment picks up, as it should, over the next fiscal, a high fiscal deficit is a prescription for excess demand and inflation. That might have warranted leaving the rates alone.

However, given the sticky transmission mechanism in India’s credit system, it is far more important for the RBI, Sebi and the government to act to reduce the structural rigidities that create segmented pools of credit in India and make monetary policy less effective than it ought to be.  India’s farm sector’s political economy demands a re-rating of farm prices in the near-term. Farm incomes are stagnant, even as farm output goes up and some procurement prices are ratcheted up. To effectively address this, price repression must be removed from farm policy, and export restrictions and restrictions on commodity derivatives must be eliminated. This is not a price shift that should or can be squeezed out via an interest rate clamp down, but its second-order effects need to be curbed. Since monetary policy takes effect with a lag, it might have been prudent to persist with the current policy rates while acting to remove rigidities in the credit system.

Source : Times Of India