A cooling economy

Data shows RBI has room for a much-needed rate cut

Official data released on Wednesday reinforced concerns that the Indian economy was slowing. The growth of index of industrial production (IIP) slowed to 1.7 per cent, year-on-year (y-o-y), the lowest in three months. Electricity generation, at 8.7 per cent, y-o-y, pushed up aggregate IIP growth; manufacturing output itself was up only 1.2 per cent, y-o-y, in May 2017, as compared to 2.3 per cent in April. The cooling of the economy was visible also in the data for consumer price index (CPI) in June 2017, which hit a new low of 1.5 per cent, down from 2.2 per cent in May. Food prices, according to the index, in fact, deflated.

The question, therefore, is the following: What arguments remain for the Reserve Bank of India (RBI) to make against a cut in interest rates? The monetary policy committee (MPC) of the RBI has got off to a good start. The new inflation-targeting regime that has been agreed on between the RBI and the government requires the MPC to maintain inflation in the zone between 2 and 4 per cent. But consumer price inflation is now below that target zone. Further, the nature of the goods and services tax, or GST, should provide some confidence about inflation, going forward. Concerns that it will raise prices may be true in general, but most components of the CPI, which the RBI is supposed to target, will reportedly, in fact, see no changes or will witness a decrease in tax incidence. There are certainly other things to be worried about — the increase in state borrowings following the spread of farm waivers, for example; the overall effect on the general government deficit of the new tax regime; and even the patchy progress of the monsoon. But questions such as these will always exist, and none of these worries seems pressing or certain enough to outweigh the obvious fact that inflation is way below the RBI’s own projection of 2-3.5 per cent for the first half of this fiscal year. Surely, this means that expectations of future inflation have been reset. If the RBI does not feel that sustained low inflation, including that for food items, can anchor expectations at a new and lower level, then questions may justifiably be raised about the point of monetary policy in the first place and the model the MPC is using.

What is also true is that while the RBI may say that inflation is its primary responsibility and not growth, it cannot avoid the fact that growth is slowing and investment is in a crisis. The temptation may be to wait and watch anyway to see exactly what the effects of the GST and the monsoon are, especially on food prices. And, indeed, a gentle recovery in food prices is inevitable. Global concerns, especially an increase in commodity prices, might also be on the RBI’s mind. But none of these concerns can be foregrounded, given the numbers. What is indisputable is that the Indian economy is cooling, and that a rate cut is not just possible but also necessary. The MPC must, of course, remain watchful, but watchfulness cannot be a permanent state of being. At some point it must be supplemented by action.