A blessing from the Fed

The Fed’s decision to hold interest rates at near zero levels — and the likelihood of the status quo continuing into the next calendar year — has significant implications for India’s monetary policy. A rate hike was never really on the cards, after the yuan’s fall and the resulting hardening of the dollar. But if a section of market observers and analysts is to be believed, it is unlikely to happen in a hurry. This marks an abrupt shift in perception from just, say, a couple of months ago, when a rate hike looked inevitable. The Fed’s guarded approach can be put down to not only the continuing weakness in US growth and jobs data, but also to the skittish global climate. US banks will have to bear with low net- interest margins for what seems like an indefinite length of time. While a sense of uncertainty may have prompted world markets to react adversely to the Fed’s move, borrowers in the real and financial sectors stand to benefit a little longer from this extended ‘quantitative easing’ (QE) party — and show renewed interest in markets such as India. A funds flow towards equities, bonds and maybe select commodities and away from gold and US treasuries, cannot be ruled out in the short run. It is not clear, though, how these borrowers will cope when the hike finally comes, a decade or so after June 2006. That could mark the end of an era of volatile capital flows to emerging economies and bring a ‘taper tantrum’ in its wake. But since the prospect does not loom over India right now, the RBI can pursue an independent monetary policy — one that uses the interest rate to address domestic policy rather than exchange rate concerns. There can be no better occasion to slash rates than on September 29 — with growth requiring a boost and inflation being subdued.

There are enough reasons for concern on the growth front. Factory output is only showing minor signs of pick-up. A growth rate of 3.5 per cent since the start of this fiscal is no different from the performance in April-July 2014-15. While consumer goods have shown improvement, from minus 3.8 per cent in April-July last year to 2.3 per cent in the corresponding period this fiscal, there has been a deceleration in capital goods output, underscoring the weak investment climate. An RBI study on trends in private corporate investment in 2014-15 and this fiscal barely suggests an improvement in sentiment.

The prospect of a fall in kharif output, as per the first advance estimates, could dent the demand for consumer goods. A demand-constrained economy needs both a fiscal and monetary response. The RBI should not repeat its earlier error of trying to contain food inflation, as that would only stymie growth. Food prices require supply-side reforms in storage, marketing and distribution. The rest of the economy needs a rate cut to lower its inventory and debt costs.

COMMENT NOW