Upasna Bhardwaj: Limited room for a policy action
India is discomfortingly slipping into prolonged period of below potential growth and persistently elevated inflation. While enough has been discussed about the receding private capacity creation amidst increased fiscal excesses, no measures have been undertaken by the policymakers to tackle the widening supply-demand balance.
Investment growth has declined sharply from an average of over 15% between FY06-FY08, to a dismal sub 6% in FY12. In fact, there are no signs of improvement, given that the numbers of new investment proposals and projects that have been stalled or delayed continue to languish near 2 year lows.
At the same time, while private consumption has been slowing, from 8.7% between FY06-FY08 to 5.5% in FY12, the decline has not been enough to offset the fall in investment, thereby pushing up the price pressures.
In its previous policy meeting, the RBI correctly highlighted that interest rates are not the key reason for the flagging investment growth in the country. The real interest rates continue to remain below the pre crisis levels when investment was flourishing. Though not explicit enough, RBI did implicitly suggest that the government’s policy inaction, lack of reforms, delays in big-ticket project approvals are some of the key deterrents to investment. At this stage if RBI was to cut rates further, it may further flare up inflationary pressures.
Looking a little deeper into developments since the previous policy review, rainfall till mid July has been 23% deficient which is likely to push up the price of several kharif crops. Indian crude oil prices have surged almost 7% and the global commodity prices have risen nearly 9%.
While, the headline WPI and CPI inflation eased for the month of June, they continue to hover well above RBI’s comfort levels, particularly the CPI inflation which remains elevated near 10%. After having strengthened towards early July, Rupee has again slipped into a weakening trajectory.
On the fiscal management side, while much was expected on the reforms front after the Prime Minister took over the Finance Ministry portfolio; unfortunately, no concrete actions have been undertaken by the Government to either ease the fiscal pressure or to erase the supply side bottlenecks to tackle the rising inflationary pressures despite a substantial slowdown in the economy.
The developments mentioned above provide little leeway for RBI to cut the Repo rate at this juncture. However, we need to wait and watch whether RBI sticks to its guidance as provided in the previous policy meeting.
Whilst RBI had cut the Repo rate by 50bps in its April policy meeting, there has been no transmission of the same in the base rates of banks, barring few that have cut by mere 10-25bps. Banks have earlier been reluctant to cut rates as systemic liquidity deficit remained high at an average of around INR 960 billion in the last quarter.
However, liquidity condition has eased substantially beginning July with an average deficit of Rs 45,000 crore (well within RBI’s comfort levels), thereby not warranting a CRR cut in the forthcoming meeting.
With benign liquidity conditions, we may however, expect some of the banks to gradually translate the earlier Repo cut into lower lending rates, even if RBI maintains a status quo on July 31.
The author is an economist at ING Vysya Bank
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