During the busy financial season when the demand for bank credit is anticipated to go up, the RBI intervention to reduce interest rates would enable banks to transmit the cut to borrowers and thereby support the growth cycle.
The maiden monetary policy announced by the new RBI Governor Urjit Patel, under the aegis of the recently constituted Monetary Policy Committee, was widely believed to take an accommodative stance towards tackling the growth-inflation dynamics. The policy has delivered overwhelmingly on the expectations and the RBI Governor is to be commended for a prudent and visionary approach while providing a policy direction to the macro-economy.
Industry is greatly encouraged by the decision by the RBI to cut policy rates by 25 basis points, the first in six months, which, even though symbolic, has sent a positive signal down the line that the RBI is now firmly focused on revving up the growth engine even while maintaining a delicate balance between growth and inflation.
The need for a rate cut and other liquidity supporting measures was intensely felt for two major reasons. Firstly, the recovery in the economy has been patchy. This is borne from the fact that GDP growth has moderated to 7.1 per cent during the first quarter of 2016-17 as against 7.5 per cent during the corresponding period last year, which is the slowest in five quarters. At the same time, industrial production has contracted and private investment is yet to gain traction.
Producer margins remain low despite low input costs, which are holding back capacity expansion and investment in industry. This is also highlighted in the CII ASCON Survey, according to which majority of sectors reported capacity utilisation in the range of 50-75 per cent during the last quarter of financial year 2016 as well as the first quarter of financial year 2017.
Nevertheless, there are firm indications that the economy would be turning the corner in the coming quarters and new growth opportunities would emerge especially during the second half of the year when the anticipated boost in demand takes root propelled by good monsoons, the Pay Commission Award and the recent reform initiatives announced by the government. The survey also shows that some improvement is expected in the second quarter, as 40 per cent of respondents have reported an expected increase in capacity utilisation to 75-100 per cent. The cut in policy rates was considered important for turning the expectations of a turnaround into reality.
Besides, our low current account deficit and robust foreign exchange reserves are the other positives which have created space for rate cuts.
Upside risks to inflation have considerably diminished on account of the recent supply side management measures taken by the government. This taken together with near normal monsoons should usher in a benign inflation trajectory during the second half of the year and bring retail inflation within the overall target mandated by the RBI. Already, retail inflation is down and WPI inflation would also follow the trail of CPI on the back of record food-production anticipated this year. This has also been conceded by the Monetary Policy Committee which has alluded to the recent downward trajectory of CPI inflation owing to a moderation in food prices which has given a leg-room to the RBI to administer a rate cut.
While the government has in recent months taken steps to rejuvenate the economy, contain inflation and improve the investment climate, much more is required at the policy and execution level to revert to the desired trajectory of growth. It is in this context that there was anticipation on RBI’s guidance on growth and inflation and its policy actions on the rate and liquidity front which would reduce the cost of capital and bring investment and growth back to the economy. The RBI decision is also timely since it has come at a time when interest rates, the world over, have been softening and credit demand by industry is flat.
The RBI’s decision to ease interest rates would provide succor to industry which has long been afflicted by weak order book conditions and create conditions for investment revival.
The rate cut would spur demand in the rate sensitive sectors like automobiles, home loans and consumer durables segment, among others thereby helping firms to resume their investment plans. The Small and Medium-sized Enterprises (SME) and the Micro, Small and Medium Enterprises (MSME) sectors would be particularly benefitted from the growthinducing shift in the monetary policy stance.
Already the real estate developers are lining up projects anticipating a demand revival spurred by the rate cut. Similar is the case with sectors such as automobiles and consumer durables which are terming the rate cut as a ‘festive gift’ by the RBI.
The benefit of lowering of policy rates would also accrue to the infrastructure and power sectors thereby kick-starting the investment cycle in these core sectors. It would lower the cost of government borrowing, give a fillip to public investment and boost private spending in infrastructure. Moreover, the approach of the RBI towards NPAs reflects pragmatism. It indicates that the problem of stressed assets should not come in the way of credit flow to important sectors within industry such as infrastructure which support growth.
Presently, we are at the threshold of the busy credit season when the spike in demand for bank credit is anticipated to go up. It is hoped that the slashing of key policy rate would nudge the banks to transmit the benefit of the cut to borrowers which in turn would trigger the growth impulses and give a boost to demand.
In short, the fourth Monetary Policy Statement marks a significant shift in the way the monetary levers would be used to handle inflation while providing a compelling template for lifting growth to higher levels by supporting revival of investment demand.
It is hoped that the government would support the RBI by keeping up the momentum of reform – continuing with infrastructure investment and work towards mitigating the problem of bad loans by banks – so that lending can be resumed for otherwise viable projects.