Millennium Post

When politics slows economy down

Predictably, with an assessment that the economy is set on disinflationary path, RBI has left the key policy (repo) rate unchanged at eight per cent, as also the cash reserve ratio and other rates, in its first bi-monthly monetary policy statement on 1 April 2014. However, while headline inflation has moderated in recent months, ‘upside risks remain in 2014-2015’ and the challenge is maintaining the disinflationary momentum over the medium term.

Governor Raghuram Rajan has also taken a sombre view of the growth outlook in fiscal 2015, given nine weeks of continuous sub-five per cent growth in 2013-2014, industrial stagnation for two years in succession, and structural constraints affecting potential output. The bi-monthly review does not revise his earlier projection of a ‘moderate’ recovery to five to six per cent in 2014-2015 but with downside risks to the central estimate of 5.5 per cent.

Rajan has listed a host of uncertainties in the new fiscal year, both structural and political factors, with the country to go through national elections in April-May. The Macro-Economic Update, released by the Governor, says:, ‘More importantly, if electoral outcomes fail to provide a stable government, the upside risks  (to growth) could accentuate. To a large part, recovery remains contingent on improvements in the investment climate’.

Lead indicators do not point to any sustained revival in industry and services as yet, and the outlook for the agricultural sector is contingent upon the timely arrival and spread of the monsoon, Rajan points out. A less-than-normal monsoon would also hold risk to the forecast of eight per cent CPI by January 2015. Other uncertain factors listed include the setting of minimum support prices for agricultural commodities and also of other administered prices, especially of fuel, fertiliser and electricity, the outlook for fiscal policy, geo-political developments and their impact on international commodity prices.

It is, however, assumed that easing of domestic supply bottlenecks and progress on the implementation of stalled projects already cleared should brighten up the growth outlook. Hopefully, as the world economy picks up in the coming months, India’s export growth could also become stronger.

On the Policy Stance, according to the statement, it would be firmly focussed on keeping the economy on a disinflationary glide path that is intended to hit eight per cent CPI inflation by January 2015 and six per cent by January 2016. At the current juncture, it is appropriate to hold the policy rate unchanged at eight per cent while allowing the rate increases undertaken during September 2013-January 2014 to work their way through the economy.

Furthermore, the statement adds, if inflation continues along the intended glide path, further policy tightening in the near term is not anticipated at this juncture. RBI would come up with its second bi-monthly policy statement on 3 June 2014. By then perhaps a clearer picture including policy intentions of a new government as also more economic data should become available. While keeping the cash reserve ratio also unchanged at 4 per cent of net demand and time liabilities of the banking system, RBI has increased the liquidity provided under seven-day and 14-day term repos from 0.5 per cent of NDTL of the banking system to 0.75 per cent, and decreased the liquidity provided under overnight repos under the LAF from 0.5 per cent of bank-wise NDTL to 0.25 per cent with immediate effect.

Consequently, the reverse repo rate under the LAF will remain unchanged at 7.0 per cent, and the marginal standing facility (MSF) rate and the Bank Rate at 9.0 per cent, as at present. In its assessment of global trends, RBI noted that while recovery was on track in 2013-2014, despite recent moderation in US and other economies and sluggishness in euro-zone, further tightening of external financing conditions and renewed volatility of capital flows are the biggest risks to the outlook of a number of emerging markets.

For India, RBI noted, more efforts may be needed to secure recovery from the prolonged slowdown. Despite some more recent positive data, industrial activity continues to be a drag on the economy, with retrenchment in both consumption and investment demand as reflected in the contraction of output of consumer durables as well as capital goods. In the quarters ahead, the boost provided by robust agricultural production in 2013 ‘may wane’, it said.

On external side, the Policy Statement notes that, with sustained inflows in the form of portfolio flows, foreign direct investment (FDI) and external commercial borrowings, the external financing conditions turned comfortable. Inflows, augmented by repayments by public sector oil marketing companies of their foreign currency obligations to the Reserve Bank during March, have led to an increase in reserves. Foreign exchange reserves stood at 298.64 billion during the week ended
21 March, an increase of over 6.5 billion dollars in the fiscal year 2014.

Professional forecasters anticipate a modest recovery in 2014-2015 with a growth rate of 5.5 per cent but this depends on other assumptions of agriculture three per cent, industry 3.5 per cent and services 6.9 per cent.

They also expect inflation to go down and WPI may average 5.8 per cent and CPI eight per cent.  Reflecting the improvement on the external side, current account deficit in fiscal 2015 is pegged at 2.4 per cent of GDP. The Macro-Economic Review says the outlook for the economy has improved over the past two months with positive business sentiment, improved consumer confidence, anticipation of modest growth recovery and some decline in inflation expectations.

The caveat to this scenario is linked to any adverse outcome on the monsoon, resurfacing of geo-political risks that could lift international commodity prices (oil, in particular) and a sharper than anticipated tapering  (by US Federal Reserve) which, the review cautions, could lead to exchange rate pass-through pressures.

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