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RBI's rate cut helps but the government must keep spending in check, follow through on reform decisions
The RBI has cut policy interest rates, albeit by a small amount. It has now clearly responded to the recent decline in inflation. Though the decline in year on year rates is marginal, the decline in the month on month, seasonally adjusted three-monthly average has now been seen for the last one quarter. This suggests that in the coming months, the forecast for the headline inflation rate is lower. It has been seen that non-food, non-fuel wholesale price index-based inflation, the "core inflation" rate that is usually the basis of the RBI's decision-making, has come down. It has also been seen that the monthly food inflation, on a similar month on month, seasonally adjusted basis, has come down sharply. In all likelihood, these two have been important inputs for the RBI's decision to cut rates.
The RBI has also cut the cash reserve ratio, which will help ease the liquidity condition in the market. The sale of dollars by the RBI to support the rupee, though small, has resulted in tighter liquidity conditions. Finance Minister P. Chidambaram is on a foreign capital raising trip that will hopefully yield results. It should reduce pressure on the rupee to depreciate, lead to less intervention by the RBI, and keep liquidity conditions easy. With the high interest rates and tight liquidity conditions, markets have also seen a decline in non-food credit growth. Along with the supply side and interest rate issues is the problem of weak balance-sheets of companies, which have a reduced demand for credit due to poor business cycle conditions both in India and the world. An increase in credit is unlikely to be seen immediately, but to the extent that it will reduce the cost of capital, it will make more projects potentially profitable and encourage higher borrowing and investment. The government's initiative on addressing the problems of stalled projects should also help.