MPC could have opted for a rate cut

| Updated on December 05, 2019

Given the dismal growth numbers, there is little to be lost in lowering interest rates and trying to spur investment

The Monetary Policy Committee surprised one and all by deciding to hold the repo rate, now at 5.15 per cent, instead of cutting it. It cited inflation fears in the coming quarter, even while revising its growth projection for FY20 from 6.1 per cent in October to an alarming 5 per cent. The steep downward revision is unprecedented, given that the MPC had projected over 7 per cent growth some three quarters back. There can be no escaping the notion that the economy has come unstuck — with both production and consumption indices in decline. Yet, the MPC’s reasons for holding on to the status quo were along expected lines. Besides arguing that the 135 basis points cut since February should be given time to take effect, the RBI Governor also cited apprehensions about inflation being ‘elevated’ in the fourth quarter.

It is notable that the RBI Governor referred to the MPC’s commitment to ‘flexible inflation targeting’ while explaining the decision to hold rates. The question is whether the MPC would have responded differently, had it been wedded to pursuing ‘multiple goals’, as before May 2016. It has been an old habit with the RBI — notably during the UPA years — to adjust monetary policy to food inflation, despite the latter being caused by supply shocks. This time, in addition to food prices, the MPC seems to apprehend a rise in core inflation arising out of the increase in telecom tariffs. Even with its inflation targeting framework, the MPC has elbowroom till inflation touches the 6 per cent mark. Why it should apprehend inflation exceeding that limit, at a time all macroeconomic indicators point to a deficiency in demand, is not clear. A relative rise in food prices may lead to an improvement in demand for industrial goods and services. In fact, it may be worth re-examining the inflation targeting framework for its relevance in a situation of endemic demand shortage. With capacity utilisation now down to 69 per cent and core sector showing signs of contraction, there is little to be lost in lowering interest rates and trying to spur investment, at 27.8 per cent of GDP in Q2, against 29.7 per cent in Q1.

It is, however, undeniable that the onus lies on fiscal policy to kickstart demand, so that credit growth picks up. Non-food credit growth rules at about 8 per cent year-on-year, despite the recent rate cuts. Rural distress and unemployment have dampened demand to a point where private final consumption expenditure growth has dropped to 3 per cent, from 9.8 per cent in Q2 of FY19. The Centre’s steps to spur investment by reducing corporate tax rates, along with RBI’s efforts to channelise funds to well-run NBFCs, will have limited effect if incomes remain uncertain. Public investment must take precedence, even if that leads to a temporary breach of the fiscal deficit target.

Published on December 05, 2019

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