Opinion Bring on the rate cut

Second, counter-cyclical macroeconomic policy that smoothened external shocks had a large role in the economy’s good post-pandemic performance. But domestic policy in the first half did not counter falling export growth with a boost to domestic demand.

Third, all macroeconomic policy levers must not be tightened simultaneously. When government spending slowed because of the election and macro-prudential policy was justifiably tightened for areas showing overheating, monetary policy needed to relax.

Fourth, there is a view that a slowdown was inevitable because of structural factors. Consumption was down because of the K-shaped recovery and would not revive without substantial reforms. But private consumption has picked up from 4 per cent last year and grown at a healthy 6 per cent. Government consumption growth has also turned from negative to positive 4.4 per cent. If income growth was weak, demand should have also fallen for services, but it has not. Services continue to do well. The post-pandemic revenge-consumption driven high growth cannot last three years. Absence of reforms can’t suddenly slow growth in one quarter. This growth slowdown, therefore, is cyclical. To prevent it from becoming entrenched, coordinated policy action is required.

Indian diversity does give its growth multiple drivers. Agriculture has recovered and services growth and exports are robust. Public investment is behind budget targets and should catch-up.But to sustain growth, monetary policy also has to do its bit. Since policy works with lags it needs to respond to signals quickly. That is partly why inflation targeting works with forward-looking variables. The MPC looks at surveys of expectations and at high frequency data, which are built into growth and inflation forecasts. It would be useful, however, to have more competitive independent forecasts.

For a long time forecasts have shown inflation falling towards the 4 per cent target, implying that expected real rates were very high, with spreads aggravated by tight liquidity. The current inflation spike is due to vegetables and seasonal effects, which are likely to reverse with the good monsoon, a short cropping cycle and falling edible oil import prices. Indian inflation targeting is flexible precisely to give room to look through transient supply shocks. A policy rate cut is long overdue.

Good monetary-fiscal coordination was another critical contributing factor in the post-pandemic high growth. There are signs of this fraying in the past few months, with the government keen to give high prices to farmers and monetary policy wary of high food inflation. Attempts to remove food from the inflation target aim to reduce pressure on the government to reduce food inflation. But the government has a lot of room to restructure its agricultural policies to support the shifting of consumer demand to non-grain food items. Thousands of crores are spent on food grains and little on vegetables.

Large money transfers to low-income women are going to further increase demand for a diversified food basket. States, therefore, must remove barriers to private participation in vegetable supply chains. Middle men have to be taken out of food supply chains so farmers can get more while the consumer pays less. Such long-term reforms will reduce short-term pressure on the government to act on food prices. There is also room to cut domestic fuel prices. If monetary policy uses all the space available to cut rates, it will encourage the government to be more supportive.

A repo rate that rises with persistent inflation is adequate to establish independence of the central bank and the credibility of inflation targeting. High real rates are not required for that.

Banks don’t want rates cut because they fear they may not be able to pass them on to depositors. But Indian bank interest margins are among the highest globally and need to come down. The large profits made in the rate rise cycle can be used to restructure. Regulators have to see through special interest groups and act in the national interest.

Since US policy under Donald Trump is likely to lead to global shocks, counter-cyclical domestic policy is all the more required to facilitate smooth catch-up growth. Over the past three years, such growth has worked towards resolving seemingly intractable problems. Multiple data sources are showing job growth picked up in 2022-23. Firms tend to hire more when growth is steady since they expect to consistently need more people. Survey data, which is more reliable for India than income tax data, shows a rapid expansion in the middle class, as poverty falls and more move up the income ladder. A few large firms no longer dominate growth, the second rank have grown faster. Many new entrants are doing well. Firms do need to be induced to invest and employ more. If these lessons are learnt and acted on, the economy can outperform once more.

The writer is former member, Monetary Policy Committee and Professor Emeritus, IGIDR