Tilting at the Windmills
The Reserve Bank hits out at (imagined?) inflation, missing the real enemy: lacklustre growth
Last week the Reserve Bank of India’s (RBI) Monetary Policy Committee ( MPC) finally ‘bowed’ to public opinion and cut interest rates. Market reaction was muted. Part of the reason was the rate cut had already been factored in.
But more importantly, RBI’s Policy Statement killed all hope the bank would ever find courage to administer that much-needed shot of adrenalin, even when lurking ghosts of inflation have been put to rest. Net result, the quantum of reduction (25 basis points) announced by RBI is woefully unequal to the task of reviving animal spirits.
The ground for a reduction in the repo rate, at which RBI infuses liquidity into the system, had already been laid out, well before the MPC met over two days on August1and 2. By June, inflation, both consumer price inflation (CPI) and wholesale price inflation (WPI), had hit record lows.
At 1.54%, the CPI for June 2017 was not only well below the target range of 2-6% set by GoI for RBI under its inflation-targeting monetary policy framework. It was almost half the April 2017 number (2.99%) that the bank described as a ‘historic low’ in its monetary policy statement of June 7.
In fact, all the reasons advanced by the MPC for staying put since October 2016, even as inflation declined and economic growth nosedived, have been demolished. The monsoon has played fair, global commodity markets are benign, disruptions posed by GST have been relatively minor and have not impacted prices so far. And last, but not the least, the 7th Pay Commission payouts have not been inflationary.
On the inflation front, therefore, there was virtually no reason for the MPC to retain its earlier (excessive?) caution. On the contrary. Even as inflation retreated, creating space for a rate cut, poor growth numbers buttressed the case for more, rather than less, aggressive rate action.
The case for a rate cut was so compelling, there was no way RBI could have ignored it. The only question that remained was whether it would play true to its conservative, inflation-targeting image and cut by 25 basis points. Or, taking a more nuanced view of the present growth-inflation dynamics, would take courage in its hands and opt for a more aggressive cut of 50 basis points.
In the event, RBI played safe and lost a golden opportunity. Whether it is factory output or core sector, signs of persistent slowdown in economic activity output are undeniable. RBI’s Policy Statement admits as much. ‘Industrial performance has weakened in April-May 2017, reflecting broadbased loss of speed in manufacturing... The weakness in the capex cycle was also evident in the number of new investments announcements falling to a 12-year low in April-June 2017, the lack of traction in the implementation of stalled projects, deceleration in the output of infrastructure goods and the ongoing de-leveraging in the corporate sector.’
All convincing reasons to stop tilting at windmills and take on the real enemy of falling growth by cutting interest rates more aggressive- ly? No. Not for the MPC or RBI, which continue to see the ghosts of inflation lurking everywhere.
This is not to suggest that low interest rates are the only missing link in India’s puzzling macroeconomic scenario. Interest cost is only one factor that corporates keep on their radar when taking investment decisions. But it is important. At a time when many large corporates are highly leveraged (read: have excessive debt on their balance sheets) a 50 basis points cut in interest rates would have helped ease their debt burden and hastened the process of de-leveraging, making space for fresh investment.
Anemic Private Investment
Additionally, public sector banks reeling under the impact of high non-performing assets and RBI’s (excessively?) strict provisioning norms would have benefited from higher treasury profits. GoI, too, would have been benefited from lower cost of borrowing even as overseas investors, looking to make a fast buck through carry trade, would have been discouraged. This would have both halted the excessive rupee appreciation and ring-fenced the exchange rate from a sharp downward correction when flows reverse.
Sure, a 50 basis points reduction in repo rates would not have translated into an equivalent reduction in bank lending rates, thanks to RBI’s bugbear, inefficient transmission. But transmission would be more than with a mere 25 basis points cut. It would improve banks’ treasury profits and stimulate demand, leading to increased capacity utilisation, and finally to investment and growth, especially if it is supported by imaginative packages akin to what is being attempted for the telecom sector.
Remember, it is lack of private corporate investment that is the single-largest factor keeping growth in the 7-7.5% mark, down from close to 10% in the ‘India Shining’ days. Remember also, that though GDP growth has picked up from the low of 5.5% in 2012-13 to 8% in 2015-16, investment has not.
In fact, the ratio of gross fixed capital formation to GDP, a measure of investment, has been going steadily downhill with the latest number for 2016-17 (26.9%), nowhere near the 38% reached in 2007-08.
Unfortunately, by taking a blinkered view of the macro-economic environment, RBI has overlooked the real problem: lacklustre growth.
For our Bankmen from La Mancha