Policy review: A case of stable and sustainable growth?

The Sixth Bi-Monthly Monetary Policy Statement 2015-16, coming in just before the government’s annual budget statement, followed market expectations. The monetary policy kept the policy repo rate unchanged at 6.75%. The RBI kept the Cash Reserve Ratio (CRR), as also the liquidity provisions under the overnight repos and the 14-day repos and long-term repos unchanged. Neither were there any changes in the Statutory Liquidity Ratio (SLR). The ‘status quo’ seems to be based on the desire to spur growth on the basis of macroeconomic stability, together with financial stability.

Governor Rajan has pointed to the grim global, as well as domestic outlook since the fifth bi-monthly statement. The weak global outlook has been driven by lower economic activity within the Emerging Market Economies (EMEs), despite the recovery in some Advanced Economies (AEs). Financial markets, especially in EMEs, remained vulnerable to volatility and capital outflows based on developments in China. As an asset class, Gold and US treasuries witnessed price increases, based on ‘safe haven demand’.

Domestic economic activity was weaker in Q3 2015-2016, attributed to agricultural and industrial growth both slowing down. Slowdown in agricultural growth can be attributed to a 23% shortfall in the north-east monsoon, affecting the rabi crop. Industrial activity was weak in Q3 2015-16 due to weak investment demand. However, Lead indicators for industry, such as the Purchasing Managers Index (PMI) point to a recovery, while those for the service sector provide mixed results.

The messages coming from the policy statement are the following:

  • Revival of private investment holds the key to a higher growth trajectory.
  • “steady disinflation, a modest current account deficit and commitment to fiscal rectitude” need to be maintained
  • There need to be “structural reforms” in the budget.

Further, and despite these concerns, there seems to be a message of a 7.4 % growth rate in 2014-15, going up to 7.6% in 2016-17. This together with a 5% retail inflation by end of 2016-17as projected in the policy stamen, makes us wonder “How?”

For, the policy statement, in its run up to the budget, seems to be ambiguous in its assessment of how the economy will tackle these thorny problems.

One, how can one speak of a 7.4-7.6% growth rate, without private investment picking up, as also fiscal consolidation in the same breath.

Two, the governor in an earlier lecture had resorted to ‘Dosa Economics’ to explain the relevance of real interest rates, and how the same were higher than three years back. The moot question is what is the relevant interest rate that spurs investments and deposits. If people are indeed driven by real interest rate considerations, and if real interest rates have declined, shouldn’t these be reflected in lower inflationary expectations.

Three, with pulse inflation continuing to be inflated, how can inflation maintain its disinflationary glide path? And if so, can this be treated as apparent or real?

Four, by the RBI’s own admission, the trajectory for the inflation will be upward, based on the implementation of the VII Pay Commission. Add to this is the uncertainty brought about through the vagaries of monsoon domestically, as also the possible adverse impacts of geo-political developments on commodity prices and financial markets.

Five, can we be complacent of the lower current account deficit, given the shrinking exports (including service imports), as also a rise in the imports that would come with a higher growth, as anticipated?

In the current global and domestic scenario, as India is viewed currently as “ a beacon of stability”, the RBI has termed the current monetary policy stance as “accommodative, even while it leaves the policy rate unchanged.” It is clear that the India growth story will essentially play out if and only of macroeconomic stability and financial stability were to go hand-in-hand. Even as interest rates are unchanged, the moot question is can we manage the macroeconomic and financial stability required for stable and sustainable growth?

*The authors teach Economics at the S.P. Jain Institute of Management and Research

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