On the eve of next bi-monthly monetary policy review [September 29, 2015], RBI governor, Raghuram Rajan is under unprecedented pressure to cut the policy repo rate [interest rate at which the apex bank lends money to commercial banks] to help government’s efforts in giving a fillip to the economy and putting it on a higher growth trajectory.
Almost all stakeholders viz., industry and commerce, investors, experts/economists are unanimous in demanding a cut. The government has thus far, restrained from taking any position and has left it to the governor to take an appropriate view [giving full respect to RBI’s autonomy]. But, in a recent statement, finance minister, Arun Jaitely made his intent very clear when he opined “common sense requires a rate cut”.
Yet, while, reiterating his accommodating stance [he said so during the last review in August as well though he left the rate untouched then], Rajan appears to be in no mood to oblige this time again. He made this known in no uncertain terms when he exhorted that “there can be no quick-fixes” to boosting growth which requires long-term solutions.”
He opined that RBI’s prime objective was “inflation targeting”; that he will keep a watch on movement in consumer price index [CPI], make its assessment about inflationary expectations keeping in mind likely trend in food and fuel cost and other commodity prices. Only thereafter, he will arrive at an appropriate decision on what to do. That sounds like a typical bureaucrat who professes to go by the rule book.
But, what if governor’s own rule book underscores the need for a rate cut. Looking at facts on the ground, that indeed appears to be the case. Even as the wholesale price index [WPI] has been in the negative territory for the 10th month in succession [since November, 2014], CPI too has been declining and was at low of 3.7% in August, 2015. This is significantly lower than the target of 6% set by RBI for January, 2016.
Even food inflation is under control and the government is confident of reining it even if there is a drop in food production. Further, the prices of crude oil and other commodities will be on a downward trajectory, courtesy substantial slow down in China on the one hand and persisting excess supply of crude in the international market on the other. So, there is strong case for moving ahead judged purely from inflation perspective.
Rajan has another yardstick on his radar viz., what happens to interest rate in USA. If, Federal Reserve Bank [FRB] were to increase, this could trigger outflow of funds from India. However, following decision of FRB [September 16-17 meeting] to defer a hike, that scare no longer exists. In fact, from a reading of commentary by Fed Chairman, Janet Yellen [wherein, she gave equal importance to turbulence in global economy for determining the rate trajectory and not just US growth and job data], it is clear that the rate hike won’t happen till the end of 2015 .
Even if it comes [unlikely though], that would still not impact India much as it is a ‘bright spot’ among emerging markets with all economic fundamentals being strong. Given the pace of reforms, emphasis on ease of doing business and increasing confidence in the ability of India to deliver under Modi, it is very unlikely that a small increase in rate differential [either due to rate hike by Fed or lowering of policy rate by Rajan] could lead to flight of capital.
We should leverage this congenial environment to use all available means to give a push to growth. Modi – government has taken major initiatives in this regard. Those include unclogging around 300 pending projects involving an investment of over Rs 10 lakh crores. During April–August, 2015, there has been a 43% surge in projects awarded in roads, railways, power plants, irrigation systems, water supply systems, mining infrastructure etc to Rs 137,000 crores. The amount for which tendering has taken place increased even sharper by 67% to Rs 232,000 crores.
These projects need to be cost effective [besides execution on fast track]. That is where reduction in cost of capital – enabled by cut in interest rate – will be very helpful. The resultant boost to the economy will help reduce stress in other linked sectors [for instance, pick up in infrastructure projects will increase demand for steel] currently suffering due to low demand. In turn, this will help banks reduce their NPAs [non-performing assets] thereby creating head room for more credit flow to the economy.
This will also take care of Rajan’s related concern that banks do not fully transmit the reduction in policy rate [during this year, against a cumulative cut of 0.75% in repo rate, they have reduced their base rate by mere 0.25% – 0.30%]. To a considerable extent, high NPAs and their impact on margins affects bank’s ability in this regard. When, NPAs are reined in, there will be increased transmission of benefit to borrowers.
Rajan’s apprehension that additional liquidity could cause inflation worries is a mere figment of imagination. This money will go to catalyse the production cycle and create jobs. It would be naive to presume that someone will use bank funds to hoard food stocks or consumers will start buying more of fruits, vegetables, fish, meat, milk etc just because banks lend more at lower rates. Likewise, oil price depends solely on global supply-demand factors and has no connection with bank credit.
Let us not view current scenario from the prism of what was happening in the past. Then, a lot of money allocated for welfare schemes [running in hundreds of thousands of crores] was ending up with dubious players who would use it for hoarding and black marketing etc. Even bank funds were flowing to project promoters of doubtful integrity who were diverting to other channels. So, the system was susceptible to price rise.
Under present dispensation, when prime minister has put all welfare schemes under strict scrutiny, release of money is linked to execution of projects on ground and even payments are made directly in to the beneficiary’s account [for instance, under MGNREGA or LPG subsidy], there is no scope for pilferage whatsoever. Likewise, there is 100% percent certainty that money lent by banks will be put to productive use only. So, susceptibility to inflation is greatly minimized.
In view of above, RBI governor should join hands with the government in giving a boost to growth by granting a cut of 0.50% to 0.75% in the repo rate. In an [unlikely] event of inflationary forces showing up again, he has the option of changing tack in the next review. But, he must not cage himself merely on apprehension!