Shameem Faizee discusses the inevitable economic slowdown bound to hit the country despite RBI rate cut which is perceived as inadequate for reversing the trend
As was expected, the Reserve Bank of India's monetary policy committee (MPC) on June 6, 2019, lowered its interest rate by 0.25 percentage points to 5.75 per cent, the third such reduction since February. With the MPC already indicating in the last two policies that inflation would not be the only factor that would drive the decision on interest rate changes, it is not really a surprise that the RBI has gone in for a rate cut, especially after rather disappointing numbers have come out on gross domestic product (GDP) growth in the fourth quarter and unemployment rate.
The GDP growth has plunged to a five-year low of 5.8 per cent during January-March, 2019, dragging down the annual growth to 6.8 per cent while the country's unemployment rate has stood at a 45-year high of 6.1 per cent. Both figures are as per the data released by the government. RBI and its Governor can claim to have done its part of the job with the MPC, unlike in the past, approving the rate cut unanimously.
How far the rate cut will be effective in either pushing up the country's economic growth or in arresting the slowdown is debatable. Experts differ and are divided on the positive impact of the rate cut. As experience goes and also by the central bank's own admission, only 21 of the cumulative 50 basis points rate cut effected by the RBI in the February and April policies has been passed on to borrowers by banks. The excuse from banks was that liquidity was tight and so deposit rates could not be cut. The excuse seems to be justifiable. Similarly, the RBI's decision to do away with its charges on NEFT Real Time Gross Settlement System (RTGS)/National Electronic Funds Transfer (NEFT) transactions is welcome provided it can, again, ensure that banks pass on the benefit to customers.
While announcing the monetary policy, the central bank also lowered India's GDP growth estimate to seven per cent for the year 2019-20 from 7.2 per cent that it forecast in April this year. It said that in the April policy, GDP growth for 2019-20 was projected at 7.2 per cent — in the range of 6.8-7.1 per cent for the first half and 7.3-7.4 per cent for the second half — with risks evenly balanced.
Data for the fourth quarter of 2018-19 indicates that domestic investment activity has weakened and overall demand has been weighed down partly by slowing exports. It further said that weak global demand due to the escalation in trade wars may further impact India's exports and investment activity. Further, private consumption, especially in rural areas, has weakened in recent months. After remaining in double digits in the previous five quarters, gross fixed capital formation (GFCF) growth too declined sharply to 3.6 per cent. Private consumption growth also moderated.
On the supply side, agriculture and allied activities contracted, albeit marginally, due to a decline in rabi production. According to the third advance estimates, foodgrains production at 283.4 million tonnes for 2018-19 was lower by 0.6 per cent compared with the previous year mainly due to lower production of rabi rice, pulses and coarse cereals. Further, private consumption, especially in rural areas, has weakened in recent months. From the monetary standpoint, a rate cut helps companies and individuals that borrow, as it lowers cost of loans provided banks pass it on. Banks would be in a position to lower lending rates in case they can lower the deposit rates. This may not always be feasible, given that growth in deposits has tended to lag that in credit, which had created a virtually permanent liquidity deficit. Also, as there is a significant part of the population that lives on interest income, there could be negative effects on such spending that hence comes back to hurt consumption. This is one reason as to why banks have not been lowering their deposit rates with alacrity.
With the drivers of growth sputtering, private consumption, investment and export growth remain subdued, and with limited fiscal space, it will be very difficult to arrest the slowdown in the economy. With drought hitting severely more than half of the country, prospects of growth are turning unlikely, resulting in further deepening of the slowdown.
(The views expressed are strictly personal)