Floundering economy limits options before RBI

The economy endured a turbulent week after industrial output tanked to an eight-year low. Factories are simply not manufacturing enough. Meanwhile, Imports contracted in October by the highest margin in FY20, sending cautionary signals on underlying demand, while retail inflation rose above the Reserve Bank of India’s (RBI) medium-term target of 4%. Signalling a collapse of pricing power of producers, core inflation, the price change of goods and services that excludes food and energy, nosedived to 3.5%, its lowest since 2012.

The telecommunication sector, which could potentially fuel the growth engines, has been pushed into crushing debt after a bruising tariff war.

Despite a helping hand by the RBI and the government, the non-banking finance companies (NBFCs) are struggling to make ends meet. The total funds raised by NBFCs grew by a meagre 9% so far in 2019-20 compared to 30% in 2017-18. NBFCs are the credit lifeline to many of the country’s small businesses.

On the investment side, even after addressing the problem of stifling corporate taxes, there is little sign of a pick-up in investment.

It may have raised corporate profits but they are still waiting for tweaks to strict land and labour laws before taking a concrete decision to invest.

Finance Minister Nirmala Sitharaman has called the public sector lenders next week with a data set on how much have they lent so far this year to NBFCs out of nearly Rs 2 lakh crore released by the RBI. The problem with banks is, they have to weigh their customers before lending. They cannot lend if the prospects of loan repayment are bad. That will only pile up their bad loans. NBFCs are certainly not good customers at the moment. So, any reprimand from the finance minister is unlikely to help transmission.

What is the remedy?

What should be the remedy as the woes begin to stack up? Should the RBI keep cutting interest rates to further bring down the cost of capital and give one more push to investment? Or should the government release more money and help the sectors which have a direct bearing on demand but hitherto not addressed?

Highly-placed sources in the finance ministry have been signalling at a significant fiscal slippage this year. And, most probably, the finance minister will have to revise this year’s tax and non-tax revenue targets downwards either while presenting the Budget or before. That explains why the government cannot do much of the heavy lifting. The government’s exuberance that the indirect tax revenues will start growing post-November and it will achieve the desired revenues from assets sale are close to irrational.

That leaves the RBI as a single firefighter at least in the near term.

The central bank, which is set to announce the monetary policy on December 5, will have three issues to do the brainstorming on.

These include, lower economic growth in the July-September quarter, the data for which is due on November 29, a higher headline retail inflation and the risk of fiscal slippage by the government. While slowing GDP would demand more proactive steps on maintaining the credit flow, a higher inflation print would warrant a pause.

But if it wishes to dive deep into core inflation, it will have no other choice than to cut interest rate.

The RBI’s medium-term target for consumer price inflation (CPI) is 4% with a band of (+/-) 2% for the period from August 2016 to March 2021.

What are the options before the RBI to deal with a rather complex set of problems? It can ignore the headline inflation print and go on easing rates because real lending rates in the system are still high.

It can give a temporary pause and wait for transmission, which usually happens with at least a two-quarter lag. (The RBI has so far this year delivered 135 basis points cut in the policy repo rate and a 100 bps in the statutory liquidity ratio, SLR, a portion, which the banks are compelled to invest in the government securities). Or, it can take a bolder step by raising its medium-term inflation target higher from 4%. Bankers do not rule that out because that will signal its undeterred focus on growth at a time when the economy is expected to witness a precipitous fall.

India’s low inflation, especially core, is signalling a weak demand. And, the RBI would, at this juncture, want it to be moderately high through increased consumption and investment that would return the pricing power to the producers and also create demand.

A consumer demand survey, which the government decided to junk, has been pointing to a steep fall even in the rural consumption. The latest industrial production data, too, for quite some time, has been showing considerable stress on non-durable consumer goods output.

This implies the demand for soaps, toothpaste, food, clothing and footwear, has also been floundering. The government may choose to ignore that but the RBI cannot be completely bereft of the truth. It has a long term mandate than the government.