Dr Subbarao, why give the economy an undeserved rate cut?

It's no fun being Duvvuri Subbarao. Every month everyone looks to him to deliver interest rate cuts, and he is damned if he does, damned if he doesn't.

In April, the Reserve Bank of India (RBI) Governor went out on a limb and cut rates by 50 basis points-unexpectedly. For inflation had not been tamed, and the government was nowhere near delivering on its budget promises of fiscal consolidation. He was roundly condemned for his inappropriate cuts.

In June, he sat on his hands, and he was again condemned for fiddling while Rome burned. But Subbarao was right: inflation was showing signs of strengthening, and government finances were about to get worse.

[caption id="attachment_396432" align="alignleft" width="380"] Tomorrow, 31 July, there will be much tut-tutting whether he cuts rates or not.AFP[/caption]

Tomorrow, 31 July, there will be much tut-tutting whether he cuts rates or not.

Consider the backdrop against which he must conduct monetary policy.

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Government is comatose: Pranab Mukherjee has left the finance ministry, and the PM, despite raising expectations of quick movement on reforms and fiscal consolidation, has done absolutely nothing for more than a month. Manmohan Singh has not delivered.

The presidential election is over, and now he is waiting for the Veep election. Meanwhile, the price of Brent crude oil has risen from nearly $90 a barrel to $107. The PM is about to miss the bus again. Subbarao has been calling for fiscal action for more than a year, but so far he has got zilch.

Inflation is raging on: While wholesale price inflation is still above 7 percent and consumer price inflation in double-digits, food inflation is rising (10.66 percent in May to 10.71 percent in June). And it could get worse. It is now clear we are into a partial drought year. The pressure will clearly be upwards.

Industry is downbeat: Industrial production is slowing, and the May IIP figure of 2.41 percent means that investment demand is not picking up, even though consumer demand is holding up - to the extent it can.

The world is in a mess: Externally, the US economy is sluggish, Britain is trouble, China is slowing down and Europe continues to muddle along without any clear roadmap to emerge from its euro disaster.

So what should Subbarao be doing now?

Looked at purely from the growth perspective, both globally and domestically, it is clear that an interest rate cut may be of some use. But not much, since investment depends on business sentiment - which is purely in the hands of Manmohan Singh and Sonia Gandhi. Neither of them has lifted a finger to improve sentiment.

Looked at from the point of view of inflation, it is clear that prices are high, and could be rising further. One reason is the poor monsoon. So food prices, both domestically and globally, will be on fire.

Moreover, the current price levels are high even without factoring in an oil prices increase - which is what we have been promised ever since Pranab left for his new abode. When that kicks in, one should expect another spike. If that doesn't happen, the budget will go for a toss-and we can expect an S&P rating downgrade -with consequences for interest rates.

Looked at from the saver's perspective, bank deposits and post-office savings schemes yield almost zero or negative interest rates. In fact, inflation is good for borrowers, not savers. Put another way, even at current interest rates, it makes more sense to borrow than to lend (save, that is). So this is hardly a reason to cut rates.

The rupee, at 55.40 to the dollar, is weak -and this is one more reason to not cut rates. A cut in rates will make the dollar look much better.

Looking at all factors, a rate cut by the Reserve Bank will almost serve no purpose. Subbarao can offer a cut, and still not get the economy out of the ditch. Nobody will thank him anyway. They will invariably ask for more.

It is best if he does nothing. He will get abused anyway. By not cutting rates, he will put the pressure back on North Block to get the budget in order. That's the real goal of this monetary policy.

For those who disagree, here are 10 reasons why cheap money will anyway not help.