Why RBI feels cutting rates is not the right solution

Earlier in the day, CLSA economist Rajeev Mallik summed up the situation pretty well when he compared India's economy to a truck which was having problems.

"The problem is in the gear box (government policies), adding more fuel in the tank (through interest rate cuts) is not going to solve the problem," Mallik told CNBC-TV18.

And the Reserve Bank of India has said the same thing in its monetary policy review; interest rate is not the only factor choking economic growth.

Following are the reasons, cited by the RBI for not reducing interest rates:

* Estimates suggest that real effective bank lending interest rates, though positive, remain comparatively lower than the levels seen during the high growth phase of 2003-08. This suggests that factors other than interest rates are contributing more significantly to the growth slowdown.

* There are several factors responsible for the slowdown in activity, particularly in investment, with the role of interest rates being relatively small. Consequently, further reduction in the policy interest rate at this juncture, rather than supporting growth, could exacerbate inflationary pressures.

* Should there be an event shock (in the Eurozone), central banks in advanced economies will likely do another round of quantitative easing. This will have an adverse impact on growth and inflation in emerging and developing economies (EDEs), particularly on oil importing countries such as India, through a possible rebound in commodity prices.

* Though international crude prices have fallen significantly from their levels in April 2012, the rupee depreciation has significantly offset its impact on wholesale prices.

* Moderation in wholesale price inflation has not transmitted to the retail level. Notwithstanding the moderation in core inflation, the persistence of overall inflation both at the wholesale and retail levels, in the face of significant growth slowdown, points to serious supply bottlenecks and sticky inflation expectations.