Monetary and fiscal policies are the two engines of growth. While the fiscal policy is annual and out with the Union Budget, the monetary policy is more dynamic and adaptive to the economic environment and conditioned by the inflation target. It matters little either for the Finance Minister or the Reserve Bank of India (RBI) Governor whether tomatoes are sold at Rs 80 a kg or potatoes at Rs 12 a kg. Inflation target of 4% still appears to leave headroom for the RBI to go in for further rate cut – a policy of continuity.
The US Federal Bank opted for a rate reduction signaling the need for buttressing the US economy in the wake of another impending recession, much to the chagrin and disappointment of Europe and the UK. Will India have to follow suit or should it go on its own? What is desirable?
Exports are on the decline. Complacence in forex reserves at the present level at around $450 billion would appear misplaced viewed against China’s reserves, even against its declining growth rate and current trade war with the US. With the UK in Brexit mode for certain — going by the promise of the present Prime Minister — by October 2019, this would further alter the trade balances globally. The present trade balance looks only a temporary comfort.
Our careful management of exports and continuous search for new markets for Indian goods call for an aggressive manufacturing policy and prevention of asset deterioration in the corporate and MSME sectors. Export of culture-related products and traditional artisan products would hold good prospect and this can happen in dynamic credit markets at affordable rates of interest and not so much with the subsidies.
View this against the backdrop of major central banks’ similar exercises this season: whether the US or Canada and Basel warnings. Financial columnists like Ian McGugan warn the Federal Bank against further rate cut. Eric Lascelles, Chief Economist at RBC Global Asset Management says: “the longer that people go in an environment of lower rates, the more accustomed they get to them – and the more difficult it is to raise borrowing costs.” This should explain the reason for the Indian banks going slow on rate cut transmission to the borrowers.
Further, the net interest incomes of banks have been looking south for the last five years. On top of it, their off-balance sheet exposures are more than the balance sheet, trending to a danger that the world economy saw in 2007 and 2008.
Stock markets largely influenced by global trends and the announcements in the Union Budget over the foreign portfolio investment (FPI) are tottering. Bond yields are also not so attractive unless they are of longer duration than 10 years. Increase in minimum public shareholding could trigger a sale of shares – but not when the market is poised for a decline. Company valuations are causing a serious concern at the moment.
Major banks, including the State Bank of India, transmitted the central bank rate cut on deposits. Domestic savings, already on the decline, could slide further. Depositors and investors looking for safe returns year after year are a disappointed lot, for they are at their near-zero return of the money held.
Consumer index and business confidence index for June 2019 give out disappointing numbers. The Indian economy is not on a borrowing spree during the last five years. Instances like Amrapali, Hiranandani and DHL have enough caution on hold for lending aggressively for real estate. Real estate and housing finance, if pushed beyond limits, would put the lending institutions in a more beleaguered position than now. Priority sector lending is anyway on low yields.
The IMF downgrade of global growth rate to 3.2% in 2019-20 is a pointer to bolstering growth through the debt route with interest rate cuts by the central banks. It should, however, be kept in mind that central banks and governments have actively encouraged debt-driven consumption and investment in order to prop up growth. Such policies alter the dynamics of credit markets.
Climate risks are accentuating credit risks. Indian banks are yet to poise themselves to cushion against such risks. When global banks take the climate risks seriously and Indian banks delay, the impact on Indian credit markets is going to be high-risk driven.
Budget lines amply indicate the necessity of more private investments to flow to key infrastructure sectors like roads, railways, airways, ports. Such investments need to come from more debt than savings and investments in the emerging low rate scenario. With the uniform corporate tax rate at 25%, the government expects that there will be more corporate participation. But the emerging context does not elude much confidence among several well-meaning economists.
If growth is a concern and if it should look only to credit markets, then infrastructure for lending needs to improve and this calls for re-positioning and reforming banks and setting up Development Banks where long-term funds will be spent for long-term purposes. Structural reforms should follow any impending rate cuts.
August first week is with expectation of a further rate cut to bolster the staring decline in growth. Is growth contingent upon debt or investment? This is a question that should deserve serious consideration in the context of risk-starved banks yet to recover from the self-built shocks of the NPA overhang.
(The author is an economist and risk management specialist)