There is now a clear wedge between what the Indian central banks says and what it does. It had spoken like a hawk, but acted like a dove. It is not just a matter of interest rates. RBI has also been increasing the liquidity in the financial system through reductions in the statutory liquidity ratio and the cash reserve ratio as well as bond purchases as part of its open market operations.
The only way to explain why Subbarao has continued on this confusing path is by looking at what has happened to economic growth and inflation in recent months. Economic growth in fiscal year 2013 is likely to be at least 50 basis points below what the central bank had projected in its third quarter review in January. Inflation at the end of March was 80 basis points below the expectation of the central bank.
In other words, the growth slowdown has been worse and the inflation data better than what RBI expected some three months ago. That could explain why Subbarao has continued to reduce interest rates despite the persistence of inflationary pressures. Read More