BREAKINGVIEWS - Rate cuts can't reverse India's investment drought

SINGAPORE Mon Sep 17, 2012 3:24pm IST

A man pulls a hand-drawn cart in front of the Reserve Bank of India (RBI) building in Mumbai January 24, 2012. REUTERS/Danish Siddiqui/Files

A man pulls a hand-drawn cart in front of the Reserve Bank of India (RBI) building in Mumbai January 24, 2012.

Credit: Reuters/Danish Siddiqui/Files

SINGAPORE (Reuters Breakingviews) - Last week the government cut fuel subsidies and eased restrictions on foreign investors. In return for this good behaviour, some people said, the Reserve Bank of India (RBI) would quickly cut interest rates. Instead, it held them on Monday. But the hopes were irrational, and the RBI was sensible to dash them.

The inflation rate surprisingly accelerated to 7.6 percent in August. That made it irresponsible for Governor D Subbarao to follow up on April's half-percentage-point cut in the policy rate. Besides, the current-account deficit, which ballooned to a record 4.2 percent of GDP in the last financial year, is unlikely to narrow to a more sustainable level soon.

The rupee has fallen 14 percent against the U.S. dollar in the past year, but that is not closing the trade gap. Exports are sputtering and the nation's energy import bill is likely to remain high. If the U.S. Federal Reserve's new quantitative easing pushes up the price of oil, the bill will rise, perhaps in the face of lacklustre global growth.

In any case, while a rate cut might make capital less expensive, there are other restraints on the publicly traded companies controlled by local entrepreneurs, the source of between 50 and 70 percent of capital expenditure between financial years 2005 and 2008, according to Jefferies' analyst Nilesh Jasani. Most notably, too many of them are already neck deep in debt.

The central bank isn't ignoring the government's efforts. Governor Subbarao said monetary policy will be used to "reinforce" pro-growth government policies and acknowledged that recent actions have paved the way for "a more favourable growth-inflation dynamic."

The next monetary policy announcement comes in six weeks. Just how much room the RBI will have by then is unclear. What is certain is that lower diesel subsidies translate into higher transportation costs for manufacturers. Inflation could perk up in coming weeks. The central bank will need to stay cautious.

CONTEXT NEWS

- The RBI left interest rates unchanged on September 17 but cut the cash reserve ratio for banks, disappointing market hopes that it would follow up the government's unexpected spate of bold reform measures by reducing borrowing costs.

- The Reserve Bank of India held its policy repo rate at 8 percent, in line with expectations in a Reuters poll conducted hours before New Delhi said on September 14 it would allow foreign direct investment in industries including supermarkets and airlines.

- On September 13, the government had announced a sharp increase in the price of heavily subsidised diesel fuel.

(The author is a Reuters Breakingviews columnist. The opinions expressed are his own)

(Editing by Edward Hadas and Sarah Bailey)

Reforms Push

REUTERS SHOWCASE

Reuters Exclusive

Reuters Exclusive

India looks to sway Americans with nuclear power insurance plan  Full Article 

To Boost Growth

To Boost Growth

Crank up public spending to revive growth - chief economic adviser.   Full Article 

Bold Steps

Bold Steps

SpiceJet rescue plan marks bold bet on Indian aviation recovery.   Full Article 

New Airline

New Airline

Tata, Singapore Air venture Vistara to take off on Jan 9.  Full Article 

Online Sales

Online Sales

Knock knock. Who's there? Amazon's best-selling holiday author.  Full Article 

26/11 Plotter

26/11 Plotter

Pakistan to challenge bail for Mumbai attack "mastermind".  Full Article 

Chinese Economy

Chinese Economy

China revises up size of 2013 economy, sees no effect on 2014 growth.  Full Article 

Reuters Poll

Reuters Poll

BSE Sensex to hit 32,980 by December 2015  Full Article 

Reuters India Mobile

Reuters India Mobile

Get the latest news on the go. Visit Reuters India on your mobile device  Full Coverage