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RBI's rate cut qualms dampens Modi's growth plans


No one doubts that central bankers are the most conservative lot. Reserve Bank of India under Raghuram Rajan has gone a step ahead in being so much extra-cautious that it keeps doubting everything under the sun to delay the much-needed rate cut. While Rajan is increasing his credibility among market-oriented economists as an "inflation-hawk" every passing day, the tight monetary policy has been slowly eroding all the growth-boosting initiatives taken by Prime Minister Narendra Modi and his team over the past six months.

If the previous government is to be blamed for "policy paralysis" in the past two years, it won’t be too harsh to opine that the delay in economic recovery this year is primarily due to the "lazy" banking by both RBI and commercial banks' who are reluctant to lower lending rates despite low inflation and ample liquidity.

Between September 2013 and January 2014, Rajan raised the benchmark policy rate repo three times each by 25 basis points to 8 per cent. He has kept the rate at that level in the past 10 months even while inflation was on the downhill. With the economy locked up in a high interest rate regime, it is not surprising that the GDP growth during July-September came in at 5.3 per cent, slower than 5.7 per cent during April-June and slightly higher than 4.7 per cent during the entire 2013-14.

RBI expects the GDP growth to remain subdued at 5.5 per cent for all of 2014-15. But going by the manufacturing growth of a measly 2 per cent during the first half of 2014-15, services sector showing a mixed trend, uncertainty over the winter crop and no major upturn in the investment cycle, growth prospects look dim.

What the macro data fails to reveal is the agony that the small businesses and retail borrowers are going through for the past few years in coping with high cost of capital, slack domestic demand and rising losses.

If rates aren't coming down soon, India Inc will keep delaying capacity expansion and green-field investment. Not to forget the stalled projects that has locked up Rs 18 lakh crore of investment. Even if we assume that RBI starts cutting rates from early 2015, as hinted by Rajan in his credit policy statement, the effect of an easy money policy will take at least 6-9 months to translate into beneficial result. All of these mean that companies will be eager to wait for rates to come down before initiating fresh investment, which in turn means Modi's efforts on Make in India, smart cities and rapid infrastructure development will have to wait for quite some time.  

RBI, however, is not in a hurry to rescue the economy from the decade's worst slump. In January, Rajan set a tall target of bringing down CPI inflation from over 10 percent to 8 per cent in a year and further to 6 per cent by January 2016. Now that CPI inflation is already below 6 per cent, a year ahead of schedule, Rajan says "there is still some uncertainty about the evolution of base effects in inflation, the strength of the on-going disinflationary impulses, the pace of change of the public’s inflationary expectations, as well as the success of the government’s efforts to hit deficit targets."

Any seasoned economist will know better that an emerging market economy like India will always have some amount of inflationary pressure as a majority of Indians are craving for a better living and hence demanding essential goods even if it becomes dearer every year. For instance, rise in the consumption of fruits, vegetables and protein-based food items is a healthy sign pointing to the fact that poverty may be receding but when it stokes food inflation and raises inflationary expectation, RBI is alarmed! The shift in policy focus from wholesale to retail inflation also created a piquant situation. While wholesale prices may be stable, retail margins are often marked up by as much as 40 per cent by traders especially during festivals, giving an impression that inflation is running amok.

Now that both WPI and CPI inflation are at multi-year low, RBI has found another excuse to delay rate cut. It is frowning at government finances pointing to weak tax revenue growth and the slow pace of disinvestment. At the same time, RBI says "the government, however, appears determined to stay on course" while endorsing the fact that fall in global crude prices and diesel price reforms will bring rich dividends to the fiscal consolidation process.

What's amusing, RBI squarely blames banks for not lowering lending rates despite fall in government and corporate bond yields. "These interest rate impulses have yet to be transmitted by banks into lower lending rates," RBI said, adding that slow bank credit growth is mirrored by increasing reliance of large corporations on commercial paper and domestic as well as external public issuances. Looking from another angle, the brunt of tight monetary policy is being borne by the MSMEs and not big corporates.

It is futile to argue whether RBI is ahead or behind the curve when it comes rate actions. Central banks of China and Korea, who are equally worried about slowdown, have cut rates in recent months to pull up their economies. But our RBI is far too matured than them, as it boldly states: "a change in the monetary policy stance at the current juncture is premature".

(The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of INCLUSION. Comments are welcome at info@skoch.in)

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