Rbi rate cut neither here, nor there

The financial markets, on the other hand, spoke with its foot down. Stock markets slipped and showed their displeasure with the RBI decision. The financial markets had hoped the RBI would announce a larger cut thereby providing them with a cause to celebrate.

Even the banks were expecting a cut in interest rate this time. State bank of India, the country's largest commercial bank, cut its savings deposit interest rates. This was also a curious decision in the run up to the monetary policy announcement.

A cut in basic policy rate by the RBI is hoped to be reflected in a cut in lending rates and not exactly in the savings rate. By cutting down savings bank interest rate you actually achieve the reverse of what the RBI would like to happen with its rate cut. In this confusing tango of the financial sector, any ordinary person would be confounded. What is the meaning of all this?

While announcing the decision of the interest rate cut, RBI Governor Dr Urjit Patel was somewhat defensive. He sought to explain why there was this meagre 25 basis point reduction in interest rate and not a deeper one. He ascribed his decision to three broad developments.

The first of these was the low present level of inflation. Latest figures showed that present price rise trend was below the trajectory RBI had set for itself. RBI had stated that inflation target should be around 4 per cent by March next year. Already the inflationary trend is around 2 per cent and therefore, there was, what is described as, "policy space for a cut".

The other two factors were the smooth roll-out of the GST, which many had expected to be somewhat disruptive. Now that GST had been implemented without much of a hitch so far, the Central bank could stand back and relax a little with a pinch of incentive for the borrowers to borrow. Larger borrowing should encourage more demand and activity, thus boosting the overall growth rate. And the third factor, which is possibly the most determining, and had egged on the RBI was the normal monsoon this year.

But then, in the context of the evident softening of the industrial performance, as shown in the production and performance figures of notable segments of the Indian industry, the RBI could have taken a more aggressive stance and cut the policy rate further. The RBI and its Governor had admitted that there was a "broad based loss of speed in manufacturing". The core sector had not performed well with coal having excess inventory, crude oil and refinery output at near stagnation and mining listless. Electricity generation is restrained by a lack in the growth of demand.

Consumer non-durables were of course growing but durables output were contracting. Above all, the capital goods sectors as always had been showing swings and at present were down; indicating structural weaknesses in the economy from lack of fresh investment. RBI's own surveys indicated a downward shift to business confidence and low capacity utilisation.

In the present industrial scenario, RBI ideally should have shown a far greater resolve and cut interest rates to encourage consumption, output and growth, through a rejuvenated investment cycle. A looming question stands unanswered: Why did the RBI not do the obvious.

Clearly what weighed with the monetary policy committee –which voted four for the marginal cut and one for status quo—was the fear of inflation resurging. "The MPC observed that while inflation has fallen to a historic low, a conclusive segregation of transitory and structural factors driving the disinflation is still elusive. In respect of inflation-sensitive vegetables, prices are recording spikes. Excess supply conditions continue to push down prices of pulses and keep those of cereals in check."

The caution here looks reasonable. We are just in the middle of the monsoon and exactly how it will spread and cover the entire country is still unknown. Depending on floods or rainfall, the farm production can still be very decisively affected. Besides, the basic factors which pushed the prices down, like relative oversupply in some items, can reverse and give rise to shortages, as we are seeing already (like in tomatoes or onions).

Additionally, two factors are already getting reversed. The global prices of oil and natural gas are rising and these exert clear pressure on domestic prices. The cause of the current fall in CPI is the drastic drop in oil prices and some deflation in select vegetables. The oil prices have been decontrolled and the rising global prices would soon start working out in the domestic prices of fuel. Therefore, some practice in caution is abundantly needed.

In fact, the Reserve bank could have been a little more cautious and shied away from a cut at all. A real review should be done in the October meeting of the monetary policy committee (MPC) by which time both the monsoon should be over and its impact on this season's crop production would be clear. Along with that, the GDP trends will also be more visible and a deep cut in interest rate could have given the right kind of signals.

But then, monetary policy has only limited effectiveness. Indeed, the RBI Governor has just given a hint to that. While saying that the government's policy for housing for all can have a singular impact on pushing up the pace of the economy, it was in the hands of the state government to really carry the scheme forward. Unless they clear the projects fast, nothing can garner pace on the ground.

The same applies to investment. You cannot invest without having the land to put up new factories or infrastructure. That is all in the limbo for years now. Unless that log jam is cleared, India cannot attain a fast track growth path.