In its macro review on the eve of the policy, the RBI concludes: “The balance of macroeconomic risks suggest continuation of the calibrated stance while increasingly focussing on growth risks.” While this suggests a rate cut, the RBI’s cautious approach is highlighted when it says “the scope for supportive monetary policy action is constrained”.

The Reserve Bank’s review acknowledges demand slowing in most areas and that the fiscal situation looks better “due to the government's repeated avowal of commitment to the revised fiscal deficit target of 5.3% of GDP”. Yet the dramatic surge in the CAD, from 3.9% in the first quarter of 2012-13 to 5.4% in the second quarter and the likelihood of this rising even more in the third will leave the country vulnerable to large external shocks.

Given how the CAD continues to rise despite the contraction in non-oil and gold imports, any sharp rise in demand resulting from a large rate cut could lead to a worsening of the CAD. And given how foreign direct investment (FDI) now finances just a fourth of the CAD, down from more than 100% in 2007-08, the RBI pegs a sustainable CAD at 2.5% of GDP, a far cry from the 4.2% its professional forecasters survey is looking for in 2012-13 — this was 3.5% in the last round. While forecasters are looking at a lower 3.5% CAD in 2013-14, the earlier forecast for this was 2.7%. There is “little alternative”, the RBI says of the CAD, “but to use expenditure-reducing policies in addition to expenditure-switching policies” to bring it down to safe levels.

The professional forecasters have reduced their GDP growth projection to 5.5% for 2012-13 from 5.7% earlier and expect a slower recovery of 6.5% in the next year. Wholesale Price Index forecasts for the fiscal are down a bit, from 7.7% in the last round to 7.5% now. The inflation forecast for 2013-14 is 7%.