The underwhelming gross domestic product growth figure for a second straight quarter-the slowest in about two years-is raising questions about how long India will remain the world’s fastest-growing major economy and the need for policy measures to meet its aspirational 8% annual growth.
For investors, a one-quarter slowdown could be a blip, but the second-quarter slump is real and the third one isn’t progressing in a way that would convince them that the economy is on the road to the 7.2% growth for the fiscal year that the RBI has forecast.This reversal comes amid the world entering a phase of even greater uncertainty with incoming US President Donald Trump threatening to upend the global economic order with tariffs, taking the world back to the mercantilist era.
The chorus for lower interest rates had been getting louder even before the release of September quarter GDP data-growth of 5.4%, below the consensus 6.5%-with both finance minister Nirmala Sitharaman and commerce minister Piyush Goyal chiming in. But the RBI is too far into the inflation fighting campaign to deliver a repo rate cut on December 6. Furthermore, such a move could do more harm than good!”A December rate cut amid still-high inflation would likely be interpreted by the market as confirmation of a sharp growth slowdown,” said Anubhuti Sahay, economist at Standard Chartered Bank. “The MPC would prefer not to send an alarmist message on economic activity, especially with growth likely to improve in the second half.”To be sure, some economists are expecting a cut in the key repo rate, at which the RBI lends banks, by 50 basis points from 6.5%, advancing the forecast of a reduction to this month from February.
The September quarter numbers showed that private consumption growth weakened to 6% from 7.5% as urban demand slumped, fixed investment growth slowed to 5.4% from 7.5%, and government consumption recovered to 4.4% growth from a 0.2% contraction in June due to elections.
This may be worrisome given that corporate earnings are also getting downgraded, and that sales are faltering. Blaming the high interest rates could be barking up the wrong tree, when for more than two years the same high rates kept the economy humming.
More than the cost of credit, it is the availability of it that is worrisome. Banks’ loan growth is down to 11.15% from more than 20% as the RBI tightened lending norms to curb imprudence and promote financial stability as deposit growth was lagging.
A number of restrictions on unsecured loans, gold loans and the imposition of a higher liquidity coverage ratio have left banks and non-banking finance companies (NBFCs) with no option but to tighten their purse strings.
Even if inflation falls to the 4% target, loans have to grow at least at 18% for the economy to grow at 8%, for which the central bank has to step in. With inflation at 6.2% in October, the central bank’s price-targeting role is clear while options to fuel growth on the regulatory front are plenty.
“Inflation breaching the upper limit of RBI’s tolerance band in October is not a favourable backdrop for the MPC to commence the easing cycle, even as the growth outcome disappointed MPC’s expectation,” said Shreya Sodhani, economist, Barclays. The RBI’s inflation target is 4% with a tolerance band of two percentage points on either side of that.
But there’s a silver lining. Agriculture growth was at 3.5%, up from 2%, and the above-normal monsoon rain and higher sowing than last year has improved the outlook for output that could bring food prices down.
The RBI may have to row back on the growth forecast with commentary that the second half could be better as the first-half performance was more due to factors such as a lengthened rainy season and seasonal factors. But similar action on the inflation front would be a relief.
It’s a fine line that the central bank has to walk this week–convincing all stakeholders that it’s ready to act to fuel economic growth without an interest rate cut, but not letting the guard down on inflation. While a cut in the cash reserve ratio (CRR) is one option, the forward guidance it gave up in the tightening cycle could return.
“It is now recognised that communication is a two-way street,” deputy governor Michael Patra said recently. “It is not just about talking. It is also about listening, in order to learn to steer the economy.”
After all, as former US Federal Reserve chair Ben Bernanke famously said, monetary policy is 98% talk and only 2% action.