RBI Walks the Talk, Now Govt Needs to Come up With Policy Support and Revive Growth

New Delhi: The Reserve Bank of India (RBI) has cut the repo rate by 35 basis points (0.35%) to 5.4%, its fourth successive rate cut this year, in a bid to boost India’s sagging economy.

In its last Monetary Policy Committee (MPC) meeting in June, India’s central bank had cut the repo rate by 25 basis points or 0.25% (100 basis points is 1%). Repo rate denotes the interest rate at which the RBI lends short-term funds to commercial banks and Wednesday’s cut is the fourth successive lowering of rates amid a deepening economic slowdown in India and calls for easing liquidity in the system.

A 35 bps cut should ideally translate into lower EMI payments for the ‘aam aadmi’, besides some long-term ease for boosting consumption demand. However, after the last three successive rate cuts were announced by the RBI, banks could not pass on the entire benefit to consumers due to rising cost of funds and the EMIs came down by insignificant amounts. Also, a cut in the repo rate may give the ‘aam aadmi’ lower returns on fixed income schemes like fixed deposits.

Not just the general public, RBI’s generous rate cut may not even help in boosting economic growth, at least, not immediately. The central bank has been doing its bit to help boost economic growth for months now, but the second player in the act – the government – has shown continued reluctance to boost public investments and take other needed policy initiatives. This has meant that the burden of growth has almost entirely fallen on the central bank’s shoulders.

Besides announcing a rate cut, the RBI has also lowered India’s GDP growth forecast for 2019-20 to 6.9% from 7% forecast earlier, puncturing the government’s claims of India continuing to grow at well above 7% this fiscal.

“Addressing growth concerns by boosting aggregate demand, especially private investment, assumes the highest priority at this juncture while remaining consistent with the inflation mandate,” the RBI said.

India’s economy has been showing distinct signs of a slowdown for months now and falling sales of key products and services since 2014, when the NDA government first came to power, stand witness to this.

An analysis by Nomura shows that domestic passenger vehicle sales were down 2.1% in three months to June but in June alone, they fell by almost a fifth.

In Q1 (April-June 2019), domestic two-wheeler sales were down 9%, tractor sales fell by about 4.5%. In May and June each, tractor sales were down by over 14%. Industrial production remained flat with a 0.7% growth in the quarter.

Passenger traffic growth in the Railways was flat at 1%, while for airlines, passenger growth has come down significantly from high double digits to under 4% in the June quarter. Sale of heavy trucks and buses was also down by about 5%.

Analysts at ratings agency CRISIL have noted that demonetisation, the ongoing trade dispute between the US and China and the Infrastructure Leasing and Financial Services (IL&FS) debacle were the three key developments which hurt India’s economic growth.

The year 2016-17 was synonymous with demonetisation (when more than 80% of the currency was suddenly taken out of the system, hurting growth). Just as its effects were petering out, came the NBFC credit crunch in 2018, caused by the IL&FS crisis. By 2018-end, weakening global trade and GDP growth, led by US-China tariff wars, had caught up.

All of these factors led to a situation where India’s economic growth came in at a five-year low of 6.8% in 2018-19, with the last quarter of that year registering a 20-quarter-low growth at 5.8%.

Various ratings agencies and analysts are now further saying that GDP growth in the April–June period or the first quarter of the new fiscal year has been even lower than the Q4 of FY19. With the RBI lowering the full year 2019-20 growth forecast to below 7%, there is no doubt about a deepening slowdown at least for the first six months of the fiscal.

The RBI said that in June, real GDP growth for 2019-20 was projected at 7% — in the range of 6.4-6.7% for H1:2019-20 (April-September 2019) and 7.2-7.5% for H2 (October 2019-March 2020) — with risks evenly balanced.

“Various high frequency indicators suggest weakening of both domestic and external demand conditions. The Business Expectations Index of the Reserve Bank’s industrial outlook survey shows muted expansion in demand conditions in Q2 (April-June), although a decline in input costs augurs well for growth. The impact of monetary policy easing since February 2019 is also expected to support economic activity, going forward. Moreover, base effects will turn favourable in H2:2019-20. Taking into consideration the above factors, real GDP growth for 2019-20 is revised downwards from 7% in the June policy to 6.9% – in the range of 5.8-6.6% for H1:2019-20 and 7.3-7.5% for H2 – with risks somewhat tilted to the downside; GDP growth for Q1:2020-21 is projected at 7.4 per cent,” the central bank said on Wednesday.

As the government remains more concerned with fiscal consolidation rather than boosting economic growth, any kickstarting of economic activity may happen only during the second half of the current fiscal or after September as the RBI’s action begin to take effect.

The CRISIL analysts quoted earlier have said that “Fiscal policy, too, has not been used to pump-prime the economy. The combined fiscal deficit of the Centre and the states stands high. The government intends to pare it down this fiscal, despite growth headwinds. To be fair, there is hardly any fiscal wiggle room with the government, and that justifies its prudent fiscal stance… We expect the rate cuts to transmit by the second half of fiscal 2020. But the fiscal policy’s ability to pump-prime the economy will remain constrained, owing to high debt levels.”

How will the rate cut announced by the RBI help?

Suvodeep Rakshit, senior economist at Kotak Institutional Equities, said, “The RBI continued with the rate cut cycle but in a surprise change to the quantum, reduced repo rate by 35 bps. While this induces some uncertainty in market expectations of the quantum of rate changes, it provides the RBI MPC with a greater degree of flexibility in signalling their intent. The 35 bps rate cut should be seen as a signal that the RBI MPC is quite concerned with the growth outlook beyond the usual 25 bps rate cut in a business-as-usual scenario (even though it does not reflect in the revised FY2020 GDP growth estimate)... Transmission to lending rates will likely remain weak unless there is a clear visibility of adequate liquidity sustaining over the medium term.”

The ball is now in the government’s court, it needs to come out with policy support and increased public investment to kickstart growth.