RBI emphasises growth over inflation, eases monetary policy

RBI emphasises growth over inflation, eases monetary policy

By Gautam Mukherjee | 8 October, 2016
RBI, inflation, monetary policy, growth, adversarial, economy
Raghuram Rajan and Urjit Patel are seen in this August 2016 photograph. The change of guard at RBI seems to have resulted in a change of approach as well. Reuters
This first monetary policy review indicates that the RBI intends to be helpful, rather than adversarial.

The rigid inflation target to be contained at 4% of CPI was, if not for the substantial infrastructure spending of this government, causing the economy to stand-still or regress over the last 30 months. It was an unprecedented Raghuram Rajan innovation and has no absolute sanctity or irrefutable logic to it. So it is good news indeed that this particular can has just been kicked down the road, from 2018 to “early 2021”, with a pointed “2% tolerance level”. The RBI is suggesting 4%-6% inflation is acceptable, even in the longer time-frame.

In one fell swoop, the new RBI Governor and the six-man monetary policy team, equally made up of RBI officials and independent, distinguished academics have unanimously dethroned the inordinate emphasis on inflation-containment at the expense of a largely stagnant economy. 

Inflation management might have been given top-billing by the previous dispensation at Mint Road. But it’s not being thrown over even now. It is just that the CPI inflation target of 5% by March 2017 still looks achievable, in fact, more so than it did in June or August 2016 because of improving circumstances.

RBI Governor Urjit Patel also announced that the country’s Central bank would henceforth be targeting domestic real neutral rates in the range of 1.25%-1.5%, down from 1.5% to 2% earlier. This lower interest regime suggests further repo rate cuts in the near term. In the face of possible inflation upticks of about 180 basis points, expected by some analysts, over the next few quarters, these clear signals from the RBI suggest it cannot be allowed to stand in the way of growth stimulus to the economy as a whole. And the 180 basis points anticipated will emanate, it is thought, from expected consumption spends from enhanced Seventh Pay Commission salaries and defence OROP sanctioned. But if this money is put into the economy as is natural, it will also stimulate demand for a host of goods and services. The inflationary projection is based on a sudden gush of money, chasing too few goods and services, but it may not necessarily turn out to be the case at all. The consumption led spending may add to the GDP in a sustained manner instead.

The confidence for the rate cut now, however, has principally come from a distinct easing of food inflation via a good monsoon. As food inflation affects the maximum numbers of poor people, it is of paramount importance. And it takes comfort from continued moderate petroleum import prices, particularly via long-term contracts entered, sustaining through to the medium term.

Overall, Governor Urjit Patel and the monetary policy committee (MPC) have lost no time in declaring for a lower interest regime, albeit with a cautious opening gambit.

They have cut both the repo and reverse repo rates by 25 basis points each, in the MPC’s very first review. The repo rate is now 6.25% and the reverse repo is at 5.75%. The cash reserve ratio (CRR) that the banks must retain at all times, has been left unchanged at 4%. This signal could well kick-start the private investment cycle, stagnant for the 30 months of the Narendra Modi government so far. It could also lower housing loan rates and awaken the languishing residential housing sector.

Predictably, therefore, the government and the Finance Minister welcomed the MPC policy stance and expected it to further boost the economy, growing at a robust 7.6% already. This is, both as per the RBI and the IMF’s estimates, and even 8% according to Niti Aayog.

The forthcoming operationalising of the GST, with a base rate at 18%, per consensus of the empowered committee to set rates is, in turn, thought to be non-inflationary by the RBI as well. But it does have the potential to raise GDP by 2% per annum and substantially boost indirect tax collections.

So, collectively, the stage is being set for compound double-digit growth year-on-year for perhaps two decades going forward. This, of course, in the absence of full-fledged war with either or both of our less-friendly neighbours. Left to our own devices, we could see the economy doubling from the $2.29 trillion at present just over the next five years. 

Overall, Governor Urjit Patel and the monetary policy committee (MPC) have lost no time in declaring for a lower interest regime, albeit with a cautious opening gambit.

The purchase power parity (PPP) numbers are already in the region of $8 trillion and therefore could reach $13-16 trillion in the next five years by the same token, inflation notwithstanding.

Business and industry plus the chambers of commerce quickly welcomed RBI’s change of stance. As did the stock market, peaking higher, absorbing the impact of a new Central bank interest rate not seen since 2010.  Relatively short maturity gilts and bonds also rallied on news of the modest rate cut and on expectations of more to come.

It remains to be seen how much and how quickly, if at all, the rate cuts are passed on to borrowers. The public sector banks feel beleaguered by their high declarations of non-performing assets (NPAs) at the urging of the previous Governor. Governor Patel, however, expressed confidence that the accumulated bad loans would not stand in the way of new lending. This, amid reports that the RBI was about to finalise parameters for at least one “bad bank” to purchase, at a discount, some of the bad loans. 

But actually many of the so called NPAs are not chronically irredeemable. Patel hinted at administrative and financial support/restructuring, saying that just five sectors of the economy—infrastructure, steel, textiles, power and telecom—collectively accounted for 61% of the stressed assets. From this listing, we can see some of the problems can be eased by government fiat and others due to global pressures, call for sympathetic handling, to carry cyclic industries over the difficult period. There is little suggestion of deliberate malfeasance, fraud or unprofessionalism to blame. 

This assessment too is a departure from harsher judgement of both bank lending norms, the way they were implemented, as well as the debtors, in the past regime.

India will prove to be an oasis of relative calm, Patel seemed to suggest, going forward, pointing to the uncertainties and slower growth in the US and the EU. Patel cited the impact of volatility in emerging markets (EMs), like India, both as a knock-on, and because of fluctuating macro-data from America and other developed economies. And while China, the second biggest economy in the world after the US now, is expected to grow only in the 6% plus band, the slowing of its vast economic engine will not only be difficult for it to manage domestically despite its massive foreign exchange reserves, but also impact the global economy adversely. China carries a great deal of the US sovereign debt, for example.

Meanwhile, through it all, the yuan has just joined the international basket of reserve currencies, a long cherished Chinese wish. 

China, with an economy at between $12-15 trillion today, and trillions of dollars in reserve, has many options to reorient its growth. Away, that is, from an over reliance on exports and domestic infrastructure building in future.

Given all these global head-winds, boosting borrowing and lending to stimulate the Indian economy, which is growing faster than any other major economy, is a very desirable objective.

While the contrasting styles of Patel and his predecessor Rajan are evident, the RBI is still extremely independent in its functioning. But this first monetary policy review indicates that it nevertheless intends to be helpful, rather than adversarial.

In a financially troubled world, battling low growth and recessionary tendencies, localised conflict and other polarities, that this is so, is just unadulterated good news.

Add new comment

This question is for testing whether or not you are a human visitor and to prevent automated spam submissions.
Enter the characters shown in the image.