A litmus test
The reducing of rates by the Reserve Bank of India — which cut the repo rate by 25 basis points on Wednesday — has opted to play safe, while nominally acceding to the clamour for softer lending rates. However, it does not appear exciting for the financial markets as such, as a cut had been priced in after the fall in Consumer Price Inflation over the last three months. The Monetary Policy Committee's majority decision (one member voted to keep rates unchanged, while another wanted a deeper cut) focussed on its observation that some 'positive risks to inflation have either condensed or not happened', opening up some seat for accommodation. Notably, the bi-monthly policy statement indicates the significant slowdown over the past three months in core inflation — retail price gains excluding those for food and fuel. It observed that the monsoon has so far been normal, and the initial roll-out of GST has been smooth. The factors daunting a more unswervingly gentle view for the path that prices are likely to pass through bear repeating, given the inflation-targeting remit handed to the MPC. Prices of inflation-sensitive tomatoes and onions are spiking. Pressures may be building that could spur higher animal protein costs for consumers. The implementation of farm loan waivers by States and the end-point, risk, that the financially spread-out measures could result in long-term price stability. On the other hand, the State governments have yet not implemented salary and allowance increases following the Centre's implementation of the seventh pay panel-related hikes. The MPC admits that there are arbitrating forces at work. It predicted that a second successive normal monsoon could check food costs and a stable international commodity price outlook and help keep the inflation trajectory favourable.
Raising concerns about economic activity, the RBI had anticipated that the high levels of stress that continue to be reflected in the balance sheets of both lenders and corporate borrowers presage the unlikelihood of any uptick in new investment. As the impulses for growth in industry and the services are weakening, the onus is now on the Centre and the States to take enabling steps, through policy measures and directed fiscal actions, to provide a timely thrust to revive private investment. The industry too has welcomed the move, which is expected to increase liquidity and hence boost activity in the economy, but experts pointed out that the RBI's monetary policy committee had cited the same economic outlook as a reason to not reduce rates in its previous meeting two months ago. While inflation has been falling each month since March, when it was at 3.81%, the effects of the tax overhaul with the implementation of the GST are yet to be seen. Its impact on prices will only start becoming evident once the first set of returns are filed in September and manufacturers claim credits for taxes paid by them. There was an inconsistency on the part of the RBI, which had been using the same set of data and circumstances to arrive at different policy decisions. But he MPC appears to have reversed its stance on inflationary expectations and reversed its call on the transitory effects of demonetisation. It seems to have taken a new normative call on the effectiveness of monetary policy in the presence of structural constraints that have been present for some time now. Despite normal monsoon and the roll-out of the Goods and Services Tax or GST has been without much disruption also offered elbow room to the MPC to make the cut this time, one cannot rule out the possibilities of rise in inflation from the current lows to 4 per cent in the last quarter of Fiscal 2017-18. In any case, it would be interesting to watch how other banks react to the move by India's largest bank, the SBI, to reduce its savings bank deposit rates by 50 basis points, from 4-3.5%. Going by the MPC's viewpoint, the underlying growth impulses in industry and services are weakening, given corporate deleveraging and cutback of investment demand. The RBI, however, has recognised that with the MPC making out a strong case for reviving private investment, removing infrastructure bottlenecks and for swifter single-window clearances by states for affordable housing which could have a knock-on impact on other industries, it would never be an easy task for the government — considering that Indian banks are weighed down by the huge pile of bad loans and gains from reforms such as the GST may mount up only after a couple of quarters. There are the grey areas, which the government has to go through with a litmus test.