RBI Votes For Growth Over Inflation

RBI Votes For Growth Over Inflation

The rigid Inflation target of 4% of the Consumer Price Index (CPI), by 2018, has been thrown over. It has now been pushed to  ‘early 2021’, with a ‘2% tolerance level’ meaning up to 6%.

The new RBI governor and the 6 man monetary policy team, equally made up of RBI officials and independent, distinguished academics, have unanimously dethroned the paramount emphasis on inflation-containment.

Not that it is being ignored. The CPI inflation target of 5% by March 2017, still looks achievable.

Governor Urjit Patel, also announced that the RBI would target domestic real neutral rates in the range of 1.25%-1.5%, instead of 1.5% to 2% earlier.  This suggests further repo rate cuts in the near term.

Some analysts expect a 180 basis points increase in inflation caused by massive consumption spends via enhanced 7^th Pay Commission gains, and Defence OROP sanctioned.

The inflationary projection however, may not prove to be correct, the consumer spending helping instead to revive the economy further, and raise the GDP levels.

The confidence for the rate cut now, has principally come from a distinct easing of food inflation via a good monsoon. And it also takes comfort from continued moderate petroleum import prices.

The Monetary Policy Committee (MPC) has cut both the repo and reverse repo rates by 25 basis points each, in its 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. It could also lower housing loan rates, and awaken the languishing residential housing sector.

It is expected it to further boost the economy, growing at a robust 7.6% already.

The forthcoming operationalising of the GST with a base rate at 18%, per  consensus of the empowered committee, is, in turn, thought to be non-inflationary. But, it will raise GDP by 2% p.a., and substantially boost indirect tax collections in future.

So, collectively, the stage is being set for sustained and compound double-digit growth. We could see the economy doubling from the $2.29 trillion at present, just over the next five years.

 The purchase power parity (PPP) numbers, already in the region of $ 8 trillion, and are also set to double to $13-16 trillion over 5 years.

Business, Industry, economists, quickly welcomed RBI’s change of stance. As did the stock markets, peaking higher, hailing the new RBI interest rate, not seen since 2010.

Shorter maturity gilts and bonds also rallied on news of the modest rate cut, and on expectations of more to come.

The public sector banks, beleaguered by high non-performing assets (NPAs), may be reluctant to pass on the interest rate cuts to borrowers.

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, also, many of the so-called NPAs are not chronically irredeemable. Patel hinted at this by 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.

Patel  pointed to the uncertainties and slower growth in the US and the EU and cited expected 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, is expected to only grow in the 6% plus band, the slowing of its vast economic engine, could be difficult to manage domestically, and impact the global economy.

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.

 On the plus side, China, with an economy at between $ 12-15 trillion, and trillions of dollars in reserve, does have options to reorient its growth.

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

For: ABP Live

(747 words)

October 6^th, 2016

Gautam Mukherjee