‘Window of opportunity to cut rates is now’

The next credit policy review, the first from the new Governor of the RBI, Urjit Patel, is due early next week. Indranil Sen Gupta, Economist & Co-Head India Research, Bank of America Merrill Lynch, a keen observer of the RBI and the economy, thinks the central bank has a short window of opportunity to cut rates now as the busy season is just ahead. Excerpts:

Will the new Governor cut rates? Would that be seen by the market as being done under pressure from the government?

The new Governor and the monetary policy committee (MPC) will do what the economy requires. Growth is weak and inflation is coming down. If they cut rates that will be a response to the macro-environment. We are expecting a 25 basis points cut on October 4 and 50 basis points cut overall by March. We are on the anvil of the busy season. If you cut rates now, chances are banks will be able to pass on the cut to the borrowers, especially given the RBI has done ₹110,000 crore of OMO. If you wait, this year is gone because banks can’t cut in the busy season.

This is what happened in 2015. The RBI cut rates in January and March. But banks could only pass on those cuts in April, when the slack season began. If you don’t cut now, then banks will not cut in this season. It will again only be in April. Looking at growth, we are seeing a very shallow recovery. In the old GDP series, we are growing at about 4.5 per cent and in the new at about 7.1 per cent. Now, arguably, this is better than the rest of the world but this is still below potential. There are now some triggers such as Pay Commission awards and better rains. But we also have to see whether some of the demand gets postponed because of GST — if you think it is going to be implemented in April, you may want to buy your car in April when it may be 5 to 10 per cent cheaper.

Do you see growth improving soon?

We don’t see that happening immediately, since there is too much of excess capacity for anyone to invest. Clearly, growth is an issue. Industrial production is contracting this year compared to 3 per cent plus last year.

Regarding inflation, we expect it to come down to 4 to 4.5 per cent this month from 5 per cent last month and 6 per cent in July. Clearly, because of rains, food prices are coming down. Pulses sowing is up 30 per cent. So, those prices will come down as well. Core inflation is already 5 per cent which is in line with the RBI target. I don’t think inflation is a constraint. So, we would hope the RBI cuts 25 bps.

Banks have not fully passed on the cuts so far. What would change now?

There were two reasons. Although the RBI cut rates, it did not provide liquidity earlier. If you see the RBI has actually started providing liquidity from early this year. That is bringing down bond yields and that will translate into lower lending rates soon. The second is that I think it will take some time. Even now most of the improvement in liquidity is seasonal. Maybe banks will be able to cut 25 bps by October. But after that RBI has to sustain the moves towards neutral liquidity for banks to be able to cut further. So, liquidity has been the prime reason why they (banks) did not pass on the rate cuts.

Isn’t government spending on public investment (roads, railways) helping liquidity flow?

No. Because overall fiscal deficit is being compressed by cuts in expenditure. There is some hope that with the recommendations of the NK Singh Committee, the government gets the cushion to support growth. But right now, it is not spending. It is cutting expenses. That is why the fiscal deficit is coming down.

Should the government start spending more?

You are now stuck in a recession that is longer than the great depression. On top of that if you keep monetary policy tight and keep fiscal deficit low, all you do is push back recovery. Ultimately, both fiscal and monetary policy have to be countercyclical for growth to happen. In which part of the world does capex happen in a recession? When you have no visibility of growth, why will you build a second factory? First interest rates have to come down, then demand will recover, then you will exhaust your current capacity and you will invest. People are putting the cart before the horse in expecting recovery quickly.

What is the problem with our exports?

Exports are doing badly because global growth is weak. Now the rupee is not a problem. The current account deficit has come down. Because of poor global growth, exports are falling and because of poor domestic growth, imports are falling. Now current account deficit is close to zero. That is not good news. That is symptomatic of the fact that there is a recession. When the economy recovers, a country like India should be running a current account deficit — borrowing from the world, not giving money to the world.

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