RBI policy: Rate cut alone wouldn’t lift economy but there aren’t many choices for Urjit Patel

A rate cut by the Reserve Bank of India (RBI) alone may not save the economy from the current slowdown phase. Governor Urjit Patel and his team at the Monetary Policy Committee (MPC) may have pressing reasons that would argue against another rate cut at this point after a token cut in August — rising CPI inflation, global commodity prices and lack of sufficient fiscal incentives to complement monetary policy actions so far. However, there aren’t many options before Patel but to deliver yet another dose of rate cut in a scenario when all other economic drivers are failing to deliver.

Make no mistake. Another 25 basis points (bps) rate cut may not do much to bring down end-consumer loan rates. Banks have stronger reasons not to scale up lending significantly other than the RBI policy cues. Hence, it will be pointless to expect tangible outcomes that could immediately show up in banks’ lending behavior. But, it could probably help build positive sentiment and prompt consumers to spend more. Yes, in a normal scenario, these aren’t enough reasons for the central bank to make a rate move. But, the current economic situation may warrant one. A recent note from rating agency Crisil showed that there is a marked improvement in the credit profile of the companies it rates in the recent months. Lowering the borrowing costs can perhaps help further to improve corporate health.

Right now, the inflation scenario may not be encouraging for the MPC to go for a big rate cut. Consumer price inflation has been inching up in the last two months. From 1.46 percent in June, the print rose to 2.36 percent in July and further to 3.36 percent in August. The base effect will likely push the inflation further in the coming months. If one looks at the inflation internals, the villain continues to be food and vegetable prices. CPI food inflation rose to 1.52 percent in August from negative levels in the preceding three months. Vegetable inflation sharply jumped to 6.16 percent in August after staying negative for three consecutive months. Certainly, the MPC will not be happy looking at these trends and think of a rate cut now. It would rather wait for a few more months before making another move.

“Inflation has been inching up in Jul-Aug since hitting a trough in Jun, with a sharper jump in core inflation. From 3.4 percent YoY in Aug, headline CPI inflation is expected to inch towards the firmer end of the 3.8-4.5 percent range by Mar ’18. Even as food inflation subsides in 4Q17, non-food factors, including lagged impact of GST changes, housing rent allowance increases and high fuel prices, along with unfavourable base effects will underpin readings,” said Radhika Rao, economist at Singapore-based DBS bank in a note.

Nevertheless, there is tremendous pressure on the MPC to cut rates in the backdrop of the sharp slowdown in economy and other drivers of growth failing to fire. GDP growth is slowing in consecutive quarters (5.7 percent in the June quarter), private investments are the lowest in several years, unemployment has emerged as a key concern, the banking sector non-performing assets (NPAs) have shot through the roof and export scenario doesn’t look very promising — all contributing to a growth drag. What has been supporting growth in recent quarters is government spending which too has lost steam now. In this backdrop, it is only logical that the onus of making the magic pill to cure the economy will fall on monetary policy.

“Not surprisingly, the committee is under pressure to ease rates in midst of slowing growth,” said Rao of DBS, adding that the central bank may also lower the growth figures in the policy. “Elsewhere, the growth outlook has deteriorated since the August review, with Jun quarter GDP down to a three-year low. This will necessitate a downward revision in the central bank’s gross value added (GVA) projection at 7.3 percent,” Rao said.

If the RBI cuts rates today, the credit should go to the rate-cut lobby in the government for pushing the MPC to save growth. As this writer has been arguing or long, the panacea for the current phase of economic slowdown isn’t monetary policy, but fiscal reforms to address structural bottlenecks in the economy. Most importantly, the Narendra Modi government will have to work urgently to get private investments back in the economy and go aggressive on the disinvestment drive. Banking sector problems should top the priority list. A rate cut can hardly unleash the animal spirits in the economy. Nevertheless, one shouldn’t be surprised if Patel and team announce a rate cut later in the day.

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