The recent move of the Reserve Bank of India (RBI) to cut repo rate by 25 basis points bringing down the benchmark rate to 6.25% from 6.50% is a seminal policy shift. More significance is the reversal of interest rate direction from upward slope to downward curve much against the expectation of industry forums. At the same time, the Monetary Policy Committee of the RBI unanimously changed its stance from ‘Calibrated Tightening’ to ‘Neutral’ to bring about flexibility in the interest rate movement.
In view of this, hope for next rate cut in the near term is strengthened. Moreover, the recent data on CPI inflation affirms the benign inflation trajectory. It slid to 2.05% in January 2019 from 2.2% recorded in December 2018.
The Reuter poll of 30 economists had predicted inflation of January 2019 to accelerate to 2.48% based on the likely correction in food prices but the reality turned out to be different, clearing the track for more rate cuts. It is the sixth straight month when the CPI inflation had clocked far below RBI’s medium-term comfort zone of 4%. Even the core inflation, representing prices of goods and services excluding food items and oil prices, too has come down to 5.4% in January 2019, from 5.7% in December 2018 allaying the fears of stickiness in non-food, non-fuel inflation. It provides a broader comfort to the trade and industry.
Monetary Policy Stance
Accordingly, the RBI in its sixth bimonthly policy revised its outlook. It projected the path of inflation to be 2.8% in the fourth quarter of 2018-19, 3.2-3.4% in the first half of FY20 and 3.9% in the third quarter of FY20, with risks broadly balanced around the central trajectory. Lower food inflation and lower rate of rise in fuel helped the steady southward move of retail inflation.
The RBI also projected the inflation outlook to remain soft in the near term while flagging certain risks which merit ‘careful monitoring’ beyond near term. These include potential reversal in vegetable prices, uncertainty in trade tensions and geopolitics, which could impact commodity prices among others. But inflation being one of the anchors to drive growth, its soft trends will help industry inputs to cost less helping boost productivity.
The downward pull in interest rate trajectory is a strategic policy initiative to reinforce the ecosystem to propel growth. Building upon the benign inflation path, the rate cut can reinstate robust positive business sentiments and psychological support to address apprehensions.
The other macroeconomic indicators also attribute potential uptick in the economy supported by early signs of growth that can be harnessed with a proactive surge in private investment and manufacturing activity. The annualised Index of Industrial Production (IIP) is down to 2.6% while the capacity utilisation in the manufacturing sector is showing a shade higher at 74.8% in Q2, from 73.8% in Q1. The Gross Value Added (GVA) during the year is expected to be 7% in FY19 compared with 6.9% in FY18. Productivity in agriculture can be placid where shortfall in rabi sowing is to be offset by extended period of cold weather boosting wheat yield.
The direct benefit transfer of farm subsidies could provide some respite to the farm sector. The RBI industrial outlook survey (IOS) for Q3 indicates weakening demand conditions in manufacturing while the business expectations index (BEI) points towards improvement in Q4. Similarly, the uptick in manufacturing purchasing managers’ index (PMI) for January 2019 is stacked with increased output supported by a new stream of orders.
Despite moderation in key indicators of the service sector, the construction sector is reviving with an uptick in the consumption of steel and production of cement. The RBI also observed that the output gap has opened up modestly as actual output has inched lower than potential. Investment activity is recovering mainly with public spending on infrastructure. The need is to strengthen private investment activity to induce private consumption.
Clouded with trade curbs and ongoing conflicts, exports clocked $271.80 billion during April-January 2018-19, 9.52% higher from the comparable period last fiscal. But higher exports were offset by a surge in imports by 11.27% reaching a level of $427.73 billion during the same period. It resulted in a trade deficit of $155.93 billion compared with $136.25 billion, widening the gulf. The bright spot, however, is the increase in net FDI inflows during November– December 2018. Foreign portfolio inflows (FPI) too rebounded in November–December. The combined impact helped foreign exchange reserves to breach the psychological mark of $400 billion.
Role of Banks
Efficient financial intermediation with the active role of banks is ‘sine qua non’ for revival of growth. It is noteworthy that bank credit is picking up much faster than during the last fiscal. The ecosystem for banks is falling in line. Stronger balance sheets should enable them to lend more. Credit growth stood at 14.5% as on February 1, 2019, as against 10.6% in the corresponding period last year.
Deposits are set to reach double-digit with 9.6% growth against 5.2% last year. Six of the 21 public sector banks have provision coverage ratio (PCR) of over 70% while 5 of them are close to 70%. Five PSU banks and one from the private sector are out of Prompt Corrective Action (PCA) and asset quality is fast improving.
The RBI has rationalised the risk weights of NBFCs and most of the pain points of exposure to Infrastructure Leasing & Financial Services (IL&FS) are being tackled with provisions made in Q3 of FY19. The relaxation in the end-use of funds accessed through external commercial borrowings (ECBs) by the RBI will be useful in speeding up debt resolution pending in the corporate insolvency resolution process (CIPR). The CIRP applicants can now borrow through the ECB route and repay local bank loans. Besides hastening loan recovery, such funds can also be used to increase the pace of bank credit.
Based on the evolving macroeconomic setting, the RBI has projected the GDP growth to be at 7.4% in FY20. It should range between 7.2% and 7.4% in H1 and 7.5% in Q3. It is, therefore, the right time for trade, industry and banks to take cognisance of diminishing interest rate regime and harness the full potentiality to overstep the evolving growth trajectory overcoming the challenges of downside risks.
(The author is Director, National Institute of Banking Studies and Corporate Management, Noida)