Tilt­ing at the Wind­mills

The Re­serve Bank hits out at (imag­ined?) in­fla­tion, miss­ing the real enemy: lack­lus­tre growth

The Economic Times - - The Edit Page - Mythili Bhus­nur­math

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.

Play­ing Safe

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

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