Sta­ble Prices Raise Rate Cut Hopes

But bad loans hold­ing back in­vest­ment, growth

The Economic Times - - The Edit Page -

On Au­gust 2, the RBI will re­view mone­tary pol­icy and, pos­si­bly, tweak pol­icy rates. Mar­kets that had run up to record highs in July are look­ing for­ward to this. The con­sen­sus among an­a­lysts is a 25-ba­sis-point cut in rates. An­a­lysts be­lieve that a re­cent drop in con­sumer price in­fla­tion (CPI) should lead to a rate cut. This is ex­pected to boost sen­ti­ments, so that in­vestors start putting money into real projects. In June, over­all CPI grew only 1.54% and food prices shrank by a lit­tle more than 2%, com­pared to the year-ago pe­riod. In an ideal econ­omy, low or fall­ing in­fla­tion should merit rate cuts, to stim­u­late in­vest­ment and growth. But rid­dled by mar­ket im­per­fec­tions and real sup­ply con­straints, In­dia is far from an ideal econ­omy.

In­deed, it is likely that when July in­fla­tion num­bers are re­leased later this month, food prices will show an abrupt in­crease. For ex­am­ple, toma­toes now sell for 120 per kg in many ur­ban mar­kets, com­pared to 20 per kg a few months ago. This is an out­come of un­timely rain and sup­ply dis­rup­tions caused by the de­mon­eti­sa­tion ex­er­cise last year. Prices of pulses and ed­i­ble oil, which had been tem­pered by an in­crease in im­ports and govern­ment in­ter­ven­tion, are also ex­pected to head north. So, it is fu­tile to project sub-4% in­fla­tion as the “new nor­mal”. In­dia has two big, re­lated prob­lems that in­ter­est-rate tweaks can­not ad­dress. These are stag­nant or shrink­ing pri­vate sec­tor in­vest­ment and the ter­ri­ble state of bank bal­ance-sheets.

In July, rat­ing com­pany Moody’s polled in­vestors in Hong Kong: 70% of re­spon­dents picked In­dia’s bank­ing sys­tem as the most vul­ner­a­ble among seven south and south­east Asian economies. In­dian banks’ bad debts are reck­oned to be around $191 bil­lion. Much of this is con­cen­trated in state-owned banks, but pri­vate lenders like Axis Bank are also dis­tressed. Most banks baulk at out­right liq­ui­da­tion, be­cause they will have to put aside100% of the bad debt for pro­vi­sion­ing. Re­struc­tur­ing has not worked. To­day, banks are un­will­ing to lend, chok­ing even vi­able projects. The RBI must fo­cus on clear­ing up this bad debt to get lend­ing, in­vest­ment and growth back on track.

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