First, the good news. India’s economy does not defy the laws of macroeconomics. With the economy growing below its potential for a year, it is heartening to see that producer pricing power is finally getting squeezed, manifested in the declining momentum of core inflation over the last few months. This will come as a welcome relief to policymakers, who have been worried by the stagflationary equilibrium that India seems to have got stuck in a declining growth but stubbornly high inflation.
This had led to calls for RBI to pull the rate trigger yesterday itself. I think the central bank was wise not to do so. The global and Indian economy are full of cross currents: Core WPI inflation is at a 33-month low, but core CPI is stuck at eight per cent; risks of fiscal slippage remain and the current account is bloated and weighing on the rupee. And let’s not forget the fiscal cliff. A timely and comprehensive solution could result in global commodities surging. Conversely, a protracted stalemate will cause risk aversion to spike and drag down the rupee, which could be inflationary (remember Q4 2011?). Given all this uncertainty, it was wise for RBI to wait it out and take stock in January. But given RBI’s guidance, it is reasonable to expect a rate cut in January and 50 bps of cuts in the first quarter of 2013. Markets are celebrating at this prospect.
But here’s the sobering news. Unless the government can continue its current reform thrust with the same zeal in 2013, the space for more monetary easing, after the first quarter, appears very limited. If the government can boost investment and control the fiscal deficit, inflation will benefit on multiple counts: Greater capacity coming on-line which puts downward pressure on core inflation, reduced aggregate demand, and a stable or appreciating currency that is disinflationary. This will naturally create more space for monetary easing. Absence of these measures could result in a large fiscal and current account deficit and a repeat of 2012: Front-loaded easing by RBI followed by disappointment.
And here’s the really important news. The true growth accelerators are not monetary, but easing supply bottlenecks on the ground: Faster federal, state and local government clearances, greater coal and raw material availability, and fair and balanced land acquisition policy.
So while markets will obsess in the coming weeks on RBI’s January review, what we should really be asking is: Will the Cabinet Committee on Investment have teeth in practice? Can the government boost the availability of coal and other raw materials? Will a balanced land acquisition Bill be passed in the Budget session? Answers in the affirmative to these questions will do far more for 2013 growth than 50-75 bps of rate cuts.
Sajjid Chinoy
India Economist, JPMorgan
