Monetary accommodation continues in push for growth

It was an anxious Monetary Policy Committee (MPC) that reduced the repo rate for the fifth consecutive time and slashed growth projections for this year from 6.9 per cent earlier to 6.1 per cent now. Its retail inflation projection of below 4 per cent for the second half of this year and beyond explains the basis for an accommodative approach going forward. In his address on Friday, the RBI Governor clearly said that high frequency indicators were not encouraging, with the prospect of good farm output providing a silver lining. While the markets have not reacted well to a 25 basis point repo rate cut — they were probably expecting more — there is a limit to which the MPC can cut rates. At the back of their mind would be the spread between the Fed and domestic rates, and the prospect of bond outflows if that gets too narrow. Given the erosion of wealth that has already taken place after the July Budget, India could do with less volatility on the external account at this stage. As the Governor rightly observed in his media briefing, the effects of the cumulative rate cut of 135 basis points as well as the new norm of ‘external benchmarking’ of lending rates of banks may require time to take effect.

But above all, there are limits to the effectiveness of monetary policy in a demand-constrained economy with ‘weak consumer sentiment’ as conceded by the RBI. The MPC has done its bit by trying to push lending through the NBFCs to priority sector, and now to households ‘at the bottom of the pyramid’, but addressing weak sentiment calls for a multi-pronged approach. The Centre’s fiscal thrust through tax cuts for the corporate sector are expected to encourage investment, but for that to happen demand needs to pick up. The responsiveness of investment to supply-side steps tax cuts or low interest rates cannot always be ascertained, more so when the economy is in deceleration mode. A counter-cyclical public spending push may be more effective in the short term, given the advantage of low inflation rates and a comfortable liquidity situation; with credit growth declining since September 2018, there is little chance of government spending crowding out private investment. Infrastructure spending must be prioritised. The lessons of ‘austerity’ in the West, after the GFC, should not be lost on India.

A recent edition of SBI’s newsletter observes that lower interest rates might have increased ‘household leverage’ more than disposable incomes. Hence, the impact of further rate cuts on consumer spending too remains uncertain, more so if the economy is not generating jobs. Interest rates as a revival instrument are a fair-weather friend. It can work in conjunction with other forces.

COMMENT NOW