Opinion Best of Both Sides | Economy is looking up. So, why rate cuts?
Liquidity in the system is optimal and supportive of growth. The healthy pick up in credit off take is evident. Credit growth from the larger ecosystem, including NBFCs and private credit, looks robust as deal volumes suggest across India Inc. where a wave of M&A activities is indicative of renewed interest in capturing markets and mindsets of consumers.
In the wake of the recent GDP data, what should the RBI do? (Illustration: C R Sasikumar) As we write this article, there are two developments that need careful investigation. One, GDP growth in the second quarter coming in much higher than expected, and its implications for the full-year estimates, against a near zero inflation print. And two, the domestic currency falling beyond the psychological barrier of 90 against the dollar.
The GDP data has reinforced the structural resilience of the domestic economy, which has benefitted from the sustainable pace of reforms that have facilitated formalisation and the ease of business with a digital-first approach. Rural demand has not shown signs of ebbing, and urban demand seems to be getting its mojo back with plateauing inflation and formalisation underpinning jobs. The booster shot from GST rate rationalisation is helping in the revival of animal spirits, with capacity utilisation of manufacturing firms hovering around 80 per cent.
In the second quarter, the services sector notched up impressive growth, led by the financial, real estate and professional services segment, while industrial activity received a boost from manufacturing and construction. With a real GDP growth of 8 per cent in the first half, overall growth for the full fiscal would be approximately 7.6 per cent or even higher. That makes the demand for a rate cut at this juncture difficult to justify. The trends being seen in household consumption are reinforced by leading indicators and growing business confidence. Further, grain storage levels are pretty good, and a bumper harvest can be expected in the rabi season, making up for any shortfall in kharif productivity.
On the external front, no red flags are visible despite the slowing capital flows. While FDI is the only accretion, slowdowns in portfolio investment flows, NRI deposits and short-term credit are cyclical in nature. Efforts to diversify exports beyond traditional geographies, aided by policy and regulatory measures, are strengthening the economic moat.
The strategic combination of supervisory and regulatory measures initiated are already playing out and various sectors are finding an optimal space conducive for growth, which should contribute to clocking higher numbers at present policy rates.
Liquidity in the system is optimal and supportive of growth. The healthy pickup in credit offtake is evident. Credit growth from the larger ecosystem, including NBFCs and private credit, looks robust, as deal volumes suggest, across India Inc. where a wave of M&A activities is indicative of renewed interest in capturing markets and mindsets of consumers. A rate cut at this point may distort the delicate growth-inflation balance, which would be detrimental to the objectives of the MPC to keep inflation along the target while ushering in a long phase of sustained growth.
With households allocating around 34 per cent of their savings to bank deposits, this class needs to be duly rewarded adequately as bank credit growth can surprise on the upside. With a much higher than average growth across credit utilisation in the MSME space (around 5.5 times of last 16 years average), and the credit pipeline of big banks showing signs of healthy demand across term as also working capital loans, the central bank can keep its dry powder ready for an opportune time. One must also caution against lowering the guard now as asset prices are showing signs of buoyancy across various classes.
The rupee breaching the psychological barrier of 90 is another important mark. The decline comes amidst the lingering impasse on trade talks and foreign portfolio investors pulling out money from equities. There are a few points to note.
First, the higher tariff imposed by the US vis-à-vis peers like China, Indonesia, Vietnam and Japan is exerting a negative effect on the currency. Second, there is renewed activity in the offshore non-deliverable forward market, which tends to drive short-term movements. Third, the trade deficit is only marginally higher than last year, so may not be exerting that much pressure. Fourth, it is possible that like in the past, continued currency depreciation is followed by appreciation.
In the midst of all this, if the RBI does indeed lower the interest rate, it would be a unique outcome considering a quarterly GDP growth of 8.2 per cent. There are very few examples of countries that have cut rates when growth is so high. It may well be the first time in India’s monetary history.
The writer is member, 16th Finance Commission, part time member, PMEAC and group chief economic advisor, State Bank of India. Views are personal
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