Beyond rate cuts

The spirits have improved following the formation of the new Government; yet, India’s economic fundamentals remain subdued as the first half of 2014-15 draws to a close. A sustainable pick-up in economic activity is yet to take root. Moreover, retail inflation remains stubbornly high, constraining the Reserve Bank from easing monetary policy.

The new Government has taken various steps to revive growth. The measures outlined in the Budget for 2014-15 have been followed up by Cabinet decisions regarding FDI and intensifying bilateral engagements with China and Japan to attract investment.

New schemes have been launched to lay the blueprint for faster growth through manufacturing, financial inclusion and a digital India. Additionally, attempts are being made to reduce impediments to project implementation, with launching of online clearances for environmental and forest approvals.

Corporate liquidity and availability of funds for long term infrastructure projects are set to improve, with some pick-up in asset sales, improved equity market sentiments, guidelines for long term bonds, and those issued by SEBI for Reits and InvITS.

However, a number of familiar constraints persist. Land acquisition, availability of feedstock and raw materials, natural gas pricing and coal block allocations remain impediments to a broad-based pick-up. Addressing such concerns would impart a far greater boost to investment activity and business confidence than a moderate cut in the repo rate.

Inflation has displayed a great deal of persistence in recent years, complicating macroeconomic management and corporate planning in India. The RBI is likely to stick to a firm anti-inflationary stance over the next six to nine months.

The recent easing of commodity prices has brightened the prospects for achieving the RBI’s interim target of CPI inflation below 8 per cent in January 2015. However, we are less sanguine about the likelihood that the eventual target of limiting CPI inflation below 6 per cent by January 2016 would be met.

Monsoon dynamics, revision in minimum support prices as well as the impact of Government measures to ease supply-side issues would critically impact prices of food items. Continued attempts at reducing leakages and eliminating subsidies would also benefit inflation management. While we expect global commodity prices to remain relatively benign over a one-year horizon, the strength of the rupee will influence landed prices in India.

Electricity tariffs are expected to display a considerable upward revision in 2015-16. While this is necessary to improve the financial health of electricity distribution companies, it nevertheless poses a risk for inflation. Tariffs may rise substantially if pass through of higher priced imports of coal or natural gas is permitted.

The commencement of an interest rate tightening cycle by the US Federal Reserve is a looming policy challenge, as it may result in exchange rate volatility. The government and the RBI would be keen to avoid a repeat of the exchange rate crisis in mid-2013.

The RBI can be expected to embark on a moderate rate easing cycle in the first quarter of 2015-16, with repo rate cuts of up to 50 basis points, if the monsoon forecast for 2015 is normal and exchange rate volatility remains contained. At the same time, the Central and state governments should expediently address supply side constraints.

The writer is MD and CEO of ICRA

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