Will the Reserve Bank of India reduce interest rates at its bi-monthly monetary policy review on December 2? Union Finance Minister Arun Jaitley, for his part, has strongly urged it to consider lowering capital costs in order to boost economic growth: “I am quite clear in my mind that the cost of capital has to come down. Inflation has moderated, global fuel price has eased. Therefore, if the RBI, which is a highly professional organisation, in its wisdom decides to bring down the cost of capital (it) will give a good fillip to the Indian economy,” he said in his address at the Citi’s Investor Summit.
This is as loud and clear as it gets on what the government expects from the central bank. The big question is whether RBI Governor Raghuram Rajan will do the needful. By keeping rates steady so far to control inflation, he has only done what his predecessor did in similar circumstances to ensure price stability at all costs. Although kick-starting growth by lowering rates is North Block’s preference, Duvvuri Subbarao did not oblige. This led the previous finance minister, P Chidambaram, to state that if the government had to walk alone to face the challenge of growth, then it would walk alone!
If Rajan chooses to hold the interest rate steady at eight per cent on December 2 – this is the rate at which banks borrow money from the RBI — the current finance minister too, will have to walk alone for some more time to tackle growth! Indications to this effect were provided by a deputy governor at the Citi function, who stated that the RBI revises rates, but not by “popular demand”; that it changes only when there is a clear conviction. On another occasion, another deputy governor argued that it was “too early” to tell whether retail inflation has fallen on a sustained basis.
These central bankers believe that even now there are upside risks for inflation than downside risks for growth. Despite the edging down of food inflation, there are indications that retail inflation might touch eight per cent by March 2015. That there might be possible upside risks to hitting the targeted six per cent by January 2016. The current downtrend is held to be more on account of higher price levels in the corresponding period earlier. The good news on inflation at lows of 5.52 per cent thus might not be sustainable. For such reasons, it might be prudent wait for some more time.
Why is the RBI obsessed only with inflation? Does it have the mandate to target only a particular rate of inflation? Not at all, as central banks all over the world have the flexibility to respond to various problems of the economy as and when they arise. So, if India’s growth outlook is muted, the RBI does have the mandate to boost economic expansion without worsening inflation. Unfortunately, the numbers on unemployment put out by the five-yearly surveys of the National Sample Survey Organisation come with a lag. But if those published by The Economist magazine are to be believed, the unemployment rate in the country was pretty high at 8.8 per cent in 2013. That there is considerable slackness in the labour market – especially among the educated youth — is beyond any doubt, as overall growth has declined sharply in recent years.
It is nobody’s case that our rate of inflation will continue to decline. This is trending down mainly because of cheaper oil globally, thanks to the US becoming the world largest producer, overtaking Saudi Arabia in the first quarter of this year. There is excess supply in the market as oil demand due to major economies in the world experiencing recession or stagnant growth has diminished. But geopolitical tensions in some oil-producing countries like Libya and Iraq are fast-growing, that can send oil prices zooming back up again. As there is a pass-through, Indian prices will rise in tandem.
Food prices, however, are a different ball game altogether, as monetary policy has less of a role to play in controlling them. They are less elevated now due to bountiful crops. For instance, high prices encouraged farmers to grow more onions last year, resulting in the current slump in prices. Higher state-advised prices for sugarcane similarly encouraged farmers to increase their acreage. But with sugar prices lower than a year ago, they will suffer, as the mills will crush less cane. In dealing with such problems, other policies are more efficacious like a stabilisation fund to protect farmers from price fluctuations.
Staring down food inflation is thus hardly a reason for the RBI to keep rates unchanged. If anything, this is the best time to aggressively reduce the repo rate to revive industrial investments that generate growth. The first quarter GDP performance this fiscal of 5.7 per cent largely reflects the base effect of depressed growth of 4.7 per cent during the same period in 2013-14. The growth numbers in the July-September and October-December quarters are likely to be equally subdued, with the prospects of overall growth expected to be around five per cent for the year as a whole.
The upshot is that a kick-start to growth warrants greater priority over inflation. Monetary policy can certainly facilitate this, by lowering the cost of capital. As the public sector banks have adequate liquidity, they must also be persuaded to step up the flow of credit to industry, especially small and medium enterprises and for infrastructural projects that are likely to come on stream. The central bank’s call on interest rates must be to revive the flagging growth of the Indian economy at its forthcoming policy review.
(N Chandra Mohan is a business and economics commentator based in New Delhi.)
