The RBI governor has stood his ground on rates. He still has some ammo left in case the slowdown gets worse - unlike the rest of the world's central bankers

Duvvuri Subbarao's first quarter review of monetary policy shows why he can now be rated as one of the best central bankers in the world today.

While the rest of the world's central bankers are busy giving money away free to rescue growth, the Reserve Bank Governor has refused the follow their failed pathways to non-growth. He thus has ammo left to rescue the economy if - and when - the going gets worse. The rest of the world has empty shells. Interest rates are near-zero in the US, UK, Japan and the eurozone. They can do little henceforth. Only Subbarao has both guns and ammo with him to fight the next slowdown.

By refusing to pander to political and business pressure to cut interest rates, he has demonstrated his independence - which is crucial to any central bank's credibility. He could have played to the gallery by making token repo rate cuts on Tuesday, but he resisted the temptation.

By offering nothing more than a one percent cut in the statutory liquidity ratio (SLR) - something that's not quite needed at this stage of easy liquidity - he is sending two messages: one to banks and the corporate sector, and the other to the government.

He has signalled to banks that they should lend to worthwhile companies, not wastrel governments. He has also subtly told the government that you shouldn't be borrowing cheap just because you're the boss. SLR is the money banks have to invest in 100 percent "safe" avenues like government bonds, and by easing this burden Subbarao is cutting off the availability of more cheap funds to government.

The most subtle message Subbarao has delivered through his do-something-but-do-nothing policy is that he knows his job. His job is to defend the value of your rupee and flag off risks to the economy.

In a complex economy - where there is no one-to-one correlation between a central bank's rate actions and economic activity - the central banker's role is that of the economy's Prime Risk Manager. Unlike politicians, who always bet on growth in the hope that it will pay for fiscal profligacy, the Reserve Bank has to guard against this moral hazard. Letting the currency fall in value means screwing savers to favour spenders and borrowers - especially a wasteful government.

Subbarao has rightly understood that by playing to the gallery now, he risks giving the politicians even more space to fool around with flawed policies when the economic situation is getting worse.

For example: food inflation is getting worse due to a poor monsoon. The rupee is still ruling weak, and crude prices are rising once again, when India has done nothing to pass on even a part of those costs to consumers. The Rs 43,000-and-odd crore funds earmarked in the budget for oil subsidies are gone, and drought relief work will mean more central expenditures, which will make the job of reining in the fiscal deficit at 5.1 percent of GDP almost impossible.

In this scenario, can any RBI governor cut rates and tell the government, we know you are messing up but here's some more money, cheaper money, to have a ball with?

By not raising rates, Subbarao is the man standing between politicians' worst instincts and fiscal chaos.

Some analysts have argued differently. How, they ask, is a high interest rate regime going to help bring down inflation, or even food prices, which is a supply-related problem?

This is true - the RBI cannot bring down food prices or inflation by rate actions, but the opposite is equally true: how is cutting rates going to help either?

Shankar Sharma, Vice-Chairman of First Global, in an interview to DNA, had this sarcastic comment to make about the RBI's tight money policy: "If you have a matriculation degree, you will understand that India's inflation has got nothing to do with the RBI's policies. Your inflation is largely international commodity price-driven. Your local interest rate policies have got nothing to do with that. We have seen that inflation has remained stubbornly high no matter what Mint Street has done. You should have understood this one commonsensical thing."

Sharma's "commonsensical" view is, of course, part nonsense. It would have landed us in a bigger mess. Indian interest rates are below CPI inflation (which is in double-digits), which means savers are getting negative interest rates. You cannot have growth without savings - and savings will fall when rates are negative.

Moreover, lending government cheap money will add to inflation. Despite a burgeoning fiscal deficit, the government is busy increasing food subsidies by raising procurement prices at a time when our granaries are bulging. All this is being financed with borrowed money. The government has done little to raise supplies in the things that add to inflation - vegetables, pulses, eggs and meat, and other protein items - but has done everything to boost demand, and hence the pressure on prices.

With T-Rex (also known as Government of India) as your main borrower, the private sector is being crowded out of cheap money. Not the best way to start investments flowing in.

In short, you don't get the economy back to the growth path with cheap rates but by giving savers a decent return on their money and by giving borrowers a positive growth environment, where the government will not eat their lunch by borrowing like crazy.

This is where Subbarao's SLR cut makes sense. SLR is essentially money lent to government. By cutting it, the governor is saying this money is better lent to private parties who may make better use of it.

This is more likely to be growth inducing that cutting rates when inflation is getting out of control.

Subbarao's guidance is crystal clear: "The primary focus of monetary policy remains inflation control in order to secure a sustainable growth path over the medium-term. While monetary actions over the past two years may have contributed to the growth slowdown - an unavoidable consequence - several other factors have played a significant role. In the current circumstances, lowering policy rates will only aggravate inflationary impulses without necessarily stimulating growth. As the multiple constraints to growth are addressed, the Reserve Bank will stand ready to act appropriately."

Shankar Sharma would be better off reading his matriculation economics books once again. Subbarao is on the right track.