Over to FM, as RBI hints at pause on rate cuts

Over to Finance Minister Nirmala Sitharaman, as RBI hints at pause on rate cuts

The RBI acted swiftly and seized the opportunity when inflation moderated last year. It gave a combined 135 basis points rate cut in five monetary policy moves to spur a laggard economy but that failed to revive investment or growth.

After using its firepower to douse the economic slowdown, the Reserve Bank of India (RBI) appears to be withdrawing for now. A week ahead of the Union Budget, it cautioned the government that the monetary policy has limitations and therefore, the government must take recourse to more fiscal measures to address the supply-side bottlenecks and boost growth.

The RBI acted swiftly and seized the opportunity when inflation moderated last year. It gave a combined 135 basis points rate cut in five monetary policy moves to spur a laggard economy but that failed to revive investment or growth. And, in turn, retail inflation, which the central bank targets for its monetary policy, rose to a 64-month high of 7.3%. The real interest rates remained elevated, for both consumers and industry reflecting transmission challenges. Not because the objective of RBI is to target inflation but because supply side bottlenecks were adding to the headline inflation, and, monetary policy cannot address that. A case in point is a 356% rise in onion prices that took place due to supply shocks but added 2 percentage points to headline CPI. This forced the government to take over and think seriously on intensifying supply-side measures so that the onion story is not replicated to other commodities.

But what should the Government do in the Budget to curb inflation and boost growth?

The Budget cannot help much in containing inflation, which is emanating from a spike in food and vegetable prices or, through a jump in crude oil rates. One is largely seasonal and the other is linked to external factors, more recently, the tensions in West Asia. But the greater worry is the core inflation, which is still low. Lower core inflation means that the demand is low. This can be addressed in the Budget through a variety of policy mixes that can incentivise domestic demand and investment. It can also address the continued weakness in exports and a temporary drags in the automobile sector, which contributes nearly 50% to the manufacturing GDP of India.

Easier said than done

The upcoming Budget appears to be more challenging than the past six Budgets of the Modi government. The first five years could pass off as those in which the government tried to fix the banking system, laden with bad loans and weak balance sheets, brought in a key structural reform, the Insolvency and Bankruptcy Code meant to speedily resolve corporate distress and redeploy resources locked in failed firms.

The Modi government’s first five years also saw a historic monetary policy overhaul, which set inflation targeting as the primary responsibility of the RBI. This was intended to bring inflation back on a particular target to be decided by the government and the RBI, failing which the central bank will have to write to the government explaining the causes. A couple of other structural changes – demonetisation and GST -- were also heralded, the jury, albeit, is still open on whether they aided to growth or to the slowdown. But, in the upcoming five years, the government will have to deliver economic growth before it is too late and unemployment becomes rampant. Therefore, the upcoming Union Budget is too challenging, where if the finance minister tries to fix the problem of slowdown, the fisc will suffer and, if she tries to save the fisc, growth, employment, investment, demand and consumption – all of these will suffer.

The advance estimate of 2019-20 economic growth has thrown up certain numbers, which are far from encouraging and the finance minister and her team who have been working overtime to set the priorities for next five years, in their Budget, based on those numbers.

What are they?

Investment in the economy is expected to grow at a rate of 1% as opposed to 10% last year. Manufacturing is likely to expand at 2% as against nearly 7% last year, a 15 year low. Private consumption is estimated to grow at 5.8% compared to 8% last year, slowest in six years, and per capita income is projected to accelerate at 6.8% against a 10% rise last year. This is slowest since 2005-06. Construction, which employs over 30 million people, is likely to grow at 3.2% from 8.7% last year, slowest since the Modi government took over in 2014.

The problem with the manufacturing slowdown is that it could eventually spread to the services sector and lead to a broader slowdown. The growth in the manufacturing sector, which has been the fulcrum of Modi’s flagship ‘Make in India’, has remained sluggish and its share in the country’s GDP, stagnant at 16-17% since the early 90s. Strong manufacturing fuels economic growth and acts as an employment multiplier. Several governments have tried to increase its share in the overall GDP to 25% but have not been sucessful.

A UBS research suggests the manufacturing shift from China due to rising costs and trade uncertainties presents India with a golden opportunity.

DH has learnt that Prime Minister Narendra Modi, who is personally involved in this year’s Budget making process and has been spending 8-9 hours per day vetting each relevant details, has put forward some out of the box ideas to spur the static manufacturing sector and slowing exports.

These could come in the form of tax amnesty, procedural simplification and rate reduction. A massive clampdown on imports is also on the cards. It may be counterproductive in the long run, but is being considered as an immediate solution to pep up domestic manufacturing, which can, to a great extent, take care of unemployment, slowing demand and consumption problems. It will also help raise the per capita incomes.

Fiscal deficit targets are being relaxed in order to up government spending and, monetisation of certain public assets are being proposed to raise revenues. The Budget is largely expected to have Modi’s imprint this year.