Balancing the scale

Sometimes, inaction is as important as action. The Reserve Bank of India on December 6 kept its basic policy rate – called the repo rate – unchanged at six per cent. Industry and business felt disappointed, saying that the RBI could have cut its repo rate and thus encouraged fresh investment. The repo rate is the interest charged by RBI for loans to banks and banks generally are expected to structure their lending rates in reference to this. The interest rate is important for setting the pace of an economy, since it is this price which determines whether an investment proposal is viable. Why is that so?

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If the lending rate charged by banks is around 13 per cent to 14 per cent, then a borrower must earn in excess of that to be viable. In the current market conditions of intense competition, few companies can, in fact, earn that much on their investments. This is more so for large projects, both manufacturing and infrastructure, and no wonder that investment has been lagging. To give a leg up to the investment process, which sets the pace of the economy, many argued, including one member of the Reserve Bank's Monetary Policy Committee (MPC), for bringing down the interest rate this time, at least for the sake of giving out a positive signal. But then, the majority of the committee members felt otherwise and opted for keeping the basic rate unchanged. Two sets of factors seem to have weighed upon the monetary policy committee to recommend keeping the repo rate unchanged.
The inflation figures are of course the most important factor for the RBI to decide on the interest rate. The recent wholesale price index, which is taken as an indication of the inflationary pressure in the economy, has shown a tendency to rise. The consumer price index had also risen inevitably. The policy statement hints at mainly cost-push inflation in the coming months. This is happening mainly as the price of fruits and vegetables have been rising fast. Some of these items have shown a fairly strong price rise. Along with that, the inputs costs of firms are rising and the RBI believes that these could be passed on to the ultimate pricing.
For one, the rise in vegetable prices seen this winter is contrary to the trend, since vegetable and fruits prices have been seen to drop in the winter months when the arrivals rise. Unseasonably this year, the prices have been rising. Adding to that, the global oil prices have also gone up, further raising pressures on the price line. The RBI fears the prospective inflation is close to five per cent, against its target of four per cent.
Second, the government's fiscal situation is also a matter of concern. Until October end, the government has already exhausted nearly all its budgeted borrowing target. Hence, the fear is that for the rest of the year there would be more borrowing and the fiscal deficit of 3.2 per cent would be exceeded. But then, at any rate, the slippage could be at most marginal and unexceptionable now that such a major tax rejig has been launched.
Third, the global situation is also changing and becoming more uncertain. The oil prices are volatile and likely to further strengthen with oil cartel OPEC deciding to continue its production cut for the next year. The US Federal Reserve is also talking of raising its interest rates and with that, the financial markets—particularly in the emerging market economies—could start showing a sharp volatility.
This litany of threats to India's price stability could be formidable for the keeper of the nation's financial stability. Hence, the wise men of the monetary policy committee would hold their armoury for a possible war on price rise, rather than try to egg on the growth momentum. Nevertheless, the RBI is not too pessimistic about the prospects of the Indian economy. The central bank has projected a GVA growth of 6.7 per cent for the second quarter but set the growth projections substantially higher at 7.5 per cent and 7.8 per cent, in the next two quarters. If these materialise, then India's growth rate average would be at above seven per cent for the whole year, which should not be a bad situation.
In the monetary policy committee's assessment, there have been several significant developments in the recent period, which "augur well" for growth prospects.
First, funds raised from the primary capital market have increased significantly after several years of sluggish activity. As the capital raised is deployed to set up new projects, it will add to the demand in the short-run and boost the growth potential of the economy over the medium-term. Second, the improvement in the ease of doing business ranking should help sustain foreign direct investment in the economy. Third, large and distressed borrowers are being referred to the authorities under the insolvency and bankruptcy code (IBC) and along with that, the public sector banks are being recapitalised. This should enhance credit flow to the efficient companies. Recapitalisation and reforms of the stressed assets of these banks should also restart the flow of credit. That should set in motion a virtuous process.
All these are hopes and fears about the immediate future. These are in a way conflicting trends and how these forces play out against each other will give the course its due shape. The RBI has to divine these forces in action. After all, policymaking is reconciling conflicting views of the future.
But even amidst such fine-tuning of the financial system, some immediate relief can come if the banks transmit the past rate cuts. One executive director of RBI has been talking about its importance at every forum. The MPC noted it and referred to in the statement: "The impact of these factors (positive and negative) can be buttressed by reducing the cost of domestic borrowings through improved transmission by banks of past monetary policy changes on outstanding loans."
That could be the end game.
(The views are strictly personal.)