This week, the Reserve Bank of India’s monetary policy committee (MPC) will meet as part of its regular bi-monthly stocktaking exercise. In all likelihood, though, the two-day meeting — whose outcome we will know on Wednesday — isn’t going to be an ordinary affair. This time’s review, after all, would be coming just after last week’s “shock” delivered by the Central Statistics Office (CSO). The CSO’s latest estimates of national income reveals the Indian economy to have recorded a sharp slide in gross value added (GVA, which is basically GDP net of taxes on goods and services) growth from 7.9% in 2015-16 to 6.6% in 2016-17. Moreover, the year-on-year growth rate has fallen in successive quarters — from 8.7% in January-March 2016 to 7.6% in April-June, 6.8% in July-September, 6.7% in October-December and 5.6% in January-March 2017.
While the last quarter’s big dip can be put down to demonetisation — that it has impacted growth quite significantly is no longer in doubt — the CSO data, however, points to the deceleration preceding the November 8 decision to invalidate all existing Rs 500 and Rs 1,000 currency notes. The current slowdown, it seems, began in July-September. Demonetisation merely exacerbated it. Nobody is able to give a clear explanation why growth fell in 2016-17. The economy looked to be on the mend, with real GVA growth registering steady improvement from 5.4% in 2012-13 and 6.2% in 2013-14 (the last two years of the UPA regime) to 6.9% in 2014-15 and 7.9% in 2015-16. With agriculture rebounding on the back of a decent monsoon (after two consecutive drought years) and exports, too, posting increase (after two successive years of decline), the 2016-17 numbers should, if at all, have been better.
There are four broad reasons being advanced for the unexpected growth slowdown that set in even before demonetisation. The first is the unresolved non-performing assets problem of banks, whose effects in terms of hampering credit growth are truly being felt now. The second has to do with the one-time stimulus to private consumption from softening global oil prices petering out by around mid-2016. The third, perhaps most important, is investment: Gross fixed capital formation (GFCF) grew by only 2.4% last fiscal. GFCF growth has been lagging overall GVA/GDP growth, when it ought to be more, as was the case during the economic boom period from 2003-04 to 2011-12. The fourth reason is government spending; even as the private sector isn’t investing, neither the Centre nor states appear in a position to take up the slack.
But whatever be the causes, one thing is clear: The five men and one woman constituting the MPC can ill afford to ignore the latest CSO “shock” data. And they would certainly be under pressure to slash the RBI’s policy interest rates. The benchmark ‘repo’ — the rate at which RBI lends overnight to banks — was last lowered from 6.5% to 6.25% on October 4. A slowing economy may not the only factor warranting a deep cut in policy rates now. The RBI’s key influencing variable (“nominal anchor”) for the conduct of monetary policy and interest rate setting is inflation based on the consumer price index (CPI). As per the monetary policy framework agreement signed between it and the Centre in February 2015, the central bank was obliged to bring down the headline or general CPI inflation rate to below 6% by January 2016. The targets for the subsequent periods were 5% by March 2017 and 4% for the medium term.
The accompanying chart shows that actual CPI inflation, which stood at 8.33% when the Narendra Modi government came to power in May 2014, fell below 6% by September — nearly one and a half years before the target date. During the 36 months from May 2014 to April 2017, the headline rate has been below 6% in 31 months, and sub-5 per cent in 16 months. Not only was the 5% target for March 2017, too, met by September 2016, but actual inflation has been lower than even the medium-term goal of 4% for the last six months! One consequence of “over-achieving” the inflation target, as Chief Economic Advisor Arvind Subramanian pointed out in a recent lecture at the Nehru Memorial Museum and Library, is that real policy (repo) rates today are at levels last seen in August 2015. Between July 2016 (when the CPI inflation was at 6.07% and the repo rate at 6.5%) and April 2017 (inflation, 2.99% and repo rate, 6.25%), the RBI’s key policy interest rate has gone up from less than 0.5% to 3.25% in real terms.
The “neutral” or “natural” real interest rate for India — which is consistent with a zero output gap (i.e. the economy growing at its potential) and low stable inflation — has been estimated at 1.6%-1.8% by the RBI’s own economists in an October 2015 working paper (http://bit.ly/2qU782h). In the present scenario, when the economy is far from overheated and its output much below potential, a minimum 50 basis point cut is probably in order. Whether RBI Governor Urjit Patel and his MPC colleagues are in any mood to oblige — after having only in February changed the central bank’s monetary policy stance from “accommodative” to “neutral” — we’ll see in two days’ time.