India Rate Cuts: Short-Term Sacrifice Of Growth Is A Small Price To Pay For Controlling Inflation, Says RBI Governor

The Reserve Bank of India will hold its mid-quarter monetary policy review June 18 amid strong demands from the industry and economists for a cut in interest rates. However, the central bank is still weighing the options on rate cuts as curtailing inflation remains top priority.

The slowing down of the Indian economy and warnings from global rating agencies of a possible downgrade have raised concerns about India's growth story.

India's GDP growth slipped to a nine-year low of 5.3 percent in the quarter ending March while the Wholesale Price Index rose to 7.55 percent in May. Indian merchandise exports posted a negative growth for the first time in months, as the data released by the Ministry of Commerce Thursday showed that exports declined by 0.69 percent at $50.13 billion in April/May from $50.48 billion in the corresponding period a year ago.

I wouldn't say that India is probably in stagflation, I would say it, most certainly, is in stagflation at the moment. Inflation is stubbornly high and growth is running a couple of percentage points below potential growth. So, I would say by that measure it's a little weak. There is downside risk, but I think in fiscal year 2013 it will struggle to hit 6%. I think we are sitting at about 6.0% at the moment, Glenn Levine, senior economist at Moody's Analytics, told CNBC-TV18 in an interview.

The economy has lost its luster due to a slack in the manufacturing output, spiraling inflation, depreciating currency, volatile markets and high foreign fund outflow. The widening current and fiscal deficit have raised alarm bells on the deteriorating condition of the Indian economy.

Global and domestic economists opine that there is an imperative need for a strong action on the policy front by both the government and the RBI. Rate cuts by the RBI on both Cash Reserve Ratio (CRR) and repo rate are widely expected in the meeting to be held June 18. However, analysts differ on the rate of cuts as the RBI cannot ignore inflation.

I think they need to cut rates quite aggressively. I would say 50 bps next week and another 50 bps at the following meeting would be a good start. Then let's wait and see how that plays out. I think cutting reserve ratios and so on and the small rate cut that they implemented at the last meeting helps, but it's not exactly decisive action, Levine said.

Meanwhile, several other analysts believe that the RBI will either choose to cut repo rates at 25 basis points, instead of the CRR rates to check inflation, or will cut both repo and CRR rates by 25 basis points, as a probability, according to Reuters.

However, economists agree that the hike in inflation has limited the elbow room for the RBI to take any kind of drastic action in its monetary policy. Any interest rate cuts can further escalate inflation, which in the current Indian political and economic situation will negatively affect the ruling UPA government's rating.

The government, which is under fire from the opposition and the public for inflation in the prices of fuel, food products and other services that directly affect the common people are on a sticky ground. Any expected policy decision for raising the investor confidence like the FDI in retail will also not get popular approval.

The analysts believe that the RBI and the government will be forced to choose between growth and containing inflation. Several corporate leaders in India, including Wipro chief Azim Premji and former Infosys chief N R Narayana Murthy, have openly criticized the government for policy inaction.

Meanwhile, RBI Governor D Subbarao said Thursday that growth would have to be sacrificed short-term to curtail inflation. Speaking in Hyderabad, the RBI Governor said that the Indian economy was much stronger than what it was during the 1991 economic crisis and that the current situation was just temporary.

You cannot control inflation without sacrificing some growth. After all, you have to contain demand. When you contain demand, growth comes down. So there is no way of bringing down inflation without sacrificing some growth. It is highly improbable that we will have 1991-type crisis because today we have different set of economy, he said, according to an IANS report.

However, for the industry and the economy which anticipate strong assurance and action from the regulatory body, any decision to maintain status quo may spell doom. Analysts believe that it is highly unlikely that the Central Bank will not do anything on the policy front.

The RBI will release its mid-quarter monetary policy review at 11 a.m. (0530 GMT) Monday.