RBI MPC meet today: Another rate cut may not help

It’s almost universally expected in India that the central bank’s monetary policy committee will lower interest rates this week.

Many expect it to keep cutting until the policy rate hits 5% by the end of the year; it was 6% in June, and the committee cut it by an unexpected 0.35 percentage points in its last meeting to bring it down to 5.4%. The arguments for a cut are manifold: The economy is clearly spluttering, with growth coming in at a shocking 5% in the last quarter for which data is available; consumer price inflation stands at 3.2%, well below the Reserve Bank of India’s mid-point target of 4%; and industry is loudly complaining that high real rates are depressing investment.

RBI Governor Shaktikanta Das told the Bloomberg India Economic Forum last month that “there’s room for a rate cut, especially when growth has slowed down.” The bond market has already been given reason to cheer this week, after the government kept its target for borrowing in the second half of the financial year constant, at Rs 2.7 trillion.

But the RBI would be wise to be cautious. The government won reelection in May by throwing money at the electorate, particularly rural voters. More recently, panicked by the sharp slowdown in growth, it has responded with fiscal measures that are likely to stress its finances, including a big cut in corporate income tax rates last month.

The larger problem here is that government finances are already in a hole. The budget the finance minister presented to Parliament in July was swiftly undermined when a senior government advisor pointed out that the tax receipts seemed outdated -- and that, in fact, revenues in the last financial year were Rs 1.7 lakh crore less than advertised.

One big reason is that the new indirect tax regime is misfiring. Evasion of a nationwide goods-and-services tax may be up and compliance down, according to government auditors. The government has cut indirect taxes arbitrarily in the past 18 months, in order to keep businesses and voters happy.

When a government cuts taxes even after a shortfall in the previous year, it’s hard to see how it will keep from borrowing more, regardless of its stated borrowing targets. As Andy Mukherjee wrote at the time, the government has unilaterally launched the money helicopter, and keeping it aloft is now the RBI’s job.

India and its central bank are both caught in a bind. All the macro figures look stable. But, simultaneously, every predictive gauge is flashing red. Enough people are convinced that historically high inflation has been brought permanently under control that calls for a demand-side stimulus are deafening. JPMorgan argued this week that the growth slowdown is “being driven by a sharp drop-off in domestic demand” because “consumption, which was increasingly financed by running down savings and taking on debt, has recently slowed sharply.” But the real problem is this: “India’s total public sector borrowing requirement is close to 9% of GDP, consuming all household financial savings.”

If the government is eating all savings anyway, it doesn’t matter what the RBI tries to do to help investment and growth.

The authorities have now denied banks the freedom to set rates on their loans, and ordered them to “adopt a uniform external benchmark.” The problem isn’t that banks are reluctant to pass on the RBI’s rate cuts; it’s that the government leaves little enough for the private sector to borrow anyway. The worst part about being the RBI right now may be the feeling of irrelevance.