Here is one useful way to understand what has happened. Consumer price inflation has slowed by around 500 basis points from its recent peak. The Reserve Bank of India has cut its benchmark repo rate by a cumulative 125 basis points ever since it began easing monetary policy. The median lending rate of banks has come down by only 60 basis points as monetary policy transmission continues to be a problem. One basis point is one-hundredth of a percentage point.

This newspaper has generally had a hawkish view on monetary policy given the rampant inflation we have seen till recently, thanks to a combination of negative real interest rates and large fiscal deficits after 2010. The asymmetrical decision to reduce policy rates at a far slower pace than the decline in inflation has thus been prudent. However, the worst of the inflation crisis seems to be behind us, partly because of the global deflationary shock emanating from China. Is it now time for the Indian central bank to go in for more rapid rate cuts?

Governor Raghuram Rajan has often spoken about three reasons why interest rates have not come down more rapidly—the risk of volatility in the financial markets in case the US Fed raises interest rates aggressively, the ability of the government to stick to a path of credible fiscal consolidation and the inflation situation (especially the persistence of food inflation). There is good news on the first two fronts. The US Fed seems to have adopted a more dovish tone in recent weeks, and one effect has been a pick-up in portfolio flows to emerging markets as well as the pause in the recent dollar rally. The budget announced by finance minister Arun Jaitley in February made a credible commitment to sticking to fiscal consolidation; the subsequent government decision to cut administered interest rates is also welcome.

Much then depends on the inflation trajectory. The Indian central bank has been formally given the task of bringing down consumer price inflation to 4% by January 2017, or about 120 basis points lower than its latest reading. Inflation has been drifting up in recent months, but it came down sharply in February. Food prices are a big part of the inflation story right now. Core inflation is less of a worry. So, a lot depends on the monsoon this year, and meteorological reports suggest that the El Niño is gradually weakening.

The battle against inflation is not quite over, but it seems that disinflation is firmly entrenched. Inflation expectations continue to be high because they are adaptive rather than forward-looking. It is our view that the Indian central bank now needs to send a strong easing signal given three realities: the dimming possibility of aggressive hikes in US interest rates, the commitment the government has shown on the fiscal front and the easing of inflation pressures. There is also a need to ease liquidity in the money market through open market operations.

The primary challenge for the Indian economy right now lies in the balance sheets of the private sector on the one hand and the banking sector on the other. The most potent risks to economic stability have moved from public finances to private sector balance sheets. There is little chance that the investment cycle will turn unless the mess in corporate finances is sorted out.

Lower interest rates are one way to ease balance sheet pressures. That is also what happened during the previous recovery in the first years of this century. There is now a compelling case for a front-loaded reduction in policy rates by a sharp 50 basis points as well as providing more liquidity to the money market. Lower borrowing costs as well as a bond rally could act as a painkiller even as the deep surgery that Rajan has spoken about continues.

Should the Reserve Bank of India go in for more rapid rate cuts? Tell us at views@livemint.com

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