Some respite

Industry is understandably relieved by the Reserve Bank of India’s surprise announcement of a 25 basis point repo rate (the overnight lending window of the RBI to banks) cut to 7.75 per cent, almost two weeks before the the central bank’s scheduled monetary policy review. The timing of the cut could not have been delayed further, since industrial output and inflation data have confirmed a trend of benign inflation and disturbingly tepid growth. The cut signals a welcome shift in monetary policy stance from tight to easy money, something which India Inc has been demanding for some time now. The dire output situation — factory output grew just 2.2 per cent between April and November this year — had called for an urgent response, especially with the fall in retail prices since July last giving the RBI enough headroom on the inflation front. The consumer price index for December was up only by 5 per cent, well below the RBI target of 8 per cent by January 2015 and 6 per cent by January 2016; a situation that gives rise to the question of whether the current scenario of anaemic growth and joblessness could have been changed by an earlier easing of rates. The RBI’s Industrial Outlook survey points to declining orders and rising inventories for the current and previous quarters. An interest rate cut can provide immediate succour on the inventories front and spur demand for automobiles, home loans and other consumer durables, reeling under recession — provided banks pass on the reduction. But for growth to return to a higher trajectory, investments have to go up, which can happen only when banks step up lending. Their current tight liquidity position and stressed balance sheets may not easily allow this.

For industry, the cut marks the end of an onerous period of rising policy rates. Between March 2009 and December 2014, the repo rate rose from 5 per cent to 8 per cent, with a brief respite between October 2011 and May 2013. The sustained hike was meant to check double digit inflation, but nothing of the sort happened. While inflation raged on right till the end of 2013-14, industrial growth fell sharply from 8 per cent levels in 2010-11. Raghuram Rajan raised rates to arrest the currency slide in mid-2013. He hiked repo rate by 75 bps between May 2013 and January 2014, holding it at 8 per cent after that. As one hopefully enters a new phase, the lessons from the last one should not be forgotten — that rate hikes may not control prices, but they can, and do, damage growth.

For the rate cut to spur output, banks need to pass on the reduction. This is not something they have been wont to do. Reduced SLR (statutory liquidity ratio) requirements and the Centre’s commitment to fiscal discipline should leave banks with room to reduce rates. Banks also need to move from risk-aversion to growth-promotion, focusing on small and medium enterprises in particular. India Inc, too, needs to seize the opportunity to deleverage balance sheets and move ahead with investments.