A cut to grow

RBI does its bit to boost economic activity

The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) has delivered its second consecutive rate cut of 25 basis points each. The broad message in the latest policy is a continuation of the sharp shift that occurred in February, when the MPC not only cut the benchmark rate for the first time since August 2017, but also changed the policy stance from “calibrated tightening” to “neutral”. That stance has been maintained this time as well because the MPC perhaps wants more clarity on uncertain factors such as the status of monsoons, fuel price trajectory and the next Budget. Crucially, the MPC rolled back its forecast for India’s gross domestic product growth in 2019-20 from 7.4 per cent earlier to 7.2 per cent. It also rolled back the inflation forecast for the year ahead. The broad message is that at a time when inflation is well contained and growth is struggling, there is a need for an impetus to boost economic activity. The RBI has made its priorities clear by stating that there is a strong need to “strengthen domestic growth impulses by spurring private investment which has remained sluggish”.

 
The latest reduction in the repo rate is thus in line with expectations. While it is true that headline retail inflation, measured by year-on-year change in the consumer price index (CPI), rose to 2.6 per cent in February after four months of continuous decline, RBI Governor Shaktikanta Das asserted that the increase had been less than anticipated. As in the recent past, the real worry is that the uptick in inflation is being driven by an increase in prices of items excluding food and fuel. But the RBI policy statement also highlighted that inflation expectations, measured by the central bank’s survey of households, declined in the February round over the previous round by 40 basis points each for the three-months ahead and for the one-year ahead horizons.

 
The main concern therefore is the deceleration in economic growth, which is what it should be as growth has indeed been anaemic. For instance, the second advance estimates for 2018-19, released by the Central Statistics Office (CSO) in February 2019, revised India’s real GDP growth downwards to 7 per cent from 7.2 per cent in the first advance estimates. This was perhaps a reflection of the deceleration in domestic consumption, both public and private. Other key indicators such as the index of industrial production (IIP) and the growth of eight core industries have also been disappointing. Indicators of investment activity such as the production of capital goods (in January) and imports of capital goods (in February) showed contraction. Of course, it is not all gloom and doom. For instance, the manufacturing purchasing managers’ index (PMI) remained in the expansion zone for 20th month in March. Similarly, indicators of the construction sector, such as consumption of steel and production of cement, have continued to show healthy growth.

 

The only disappointment was that the policy did little to address concerns over weak transmission of interest rate reductions. Banks have only reduced their lending rates by a token 5-10 basis points after the RBI’s last 25 bps cut in February. In that context, the markets, which were looking for a change in the liquidity stance, were disappointed with just a general assurance that adequate liquidity would be provided to the banking system.