Growth has sharply slowed — for Q1 FY19 it was 8 per cent while for Q2 FY20 4.5 per cent. A casualty of this is the debate on India’s official growth statistics as nobody credible seems to question them anymore. Moreover, we must remember that the average growth rate for the NDA between 2014-19 was at 7.5 per cent while under UPA-2 it was at 6.9 per cent.
The reason for the current slowdown is the massive credit bubble of the last decade bursting along with, and to some extent caused by, the high real interest rates over the last few years. Mortgage and fixed deposit rates almost a decade ago were marginally higher than now even though nominal growth has fallen by around 10 percentage points. With residential real estate in a crisis, the shadow banking sector is also in a crisis.
The fiscal deficit has reduced from 4.7 per cent of GDP in 2013 to 3.5 per cent in the last five years — yes, it will go up this year and if we combine with states and off-book items, the number is higher, but that has always been the case. One must adjust for not just the Food Corporation debt but also normalise for the latest Pay Commission’s calendar. The government must come clean on the fiscal gap and announce a more realistic consolidation roadmap with enough space for counter-cyclical deficits and automatic stabilisers. Fifty bps of GDP is not enough during downturns. As Sri Thiruvadanthai of the Jerome Levy Forecasting Centre has pointed out, the Centre’s debt to GDP ratio was around 20 percentage points higher at the beginning of the last boom cycle in 2003-04. The government should, through PPPs and EPC combined with Toll Operate Transfer (TOT)/Infrastructure Investment Trusts, fund a $1 trillion of infrastructure over five years.
Inflation has largely remained below the 4 per cent target. Core and especially wholesale inflation have been falling. Further, a range of 2-6 per cent has to be treated symmetrically rather than treating 4 per cent as a de facto ceiling. The average CPI number of 4.5 per cent during 2014-19, which is in contrast to the inflation rate of 10.2 per cent during 2009-14. What the RBI should do is to come out with a real rates framework with a publicly-declared neutral rate. While inflation targeting should remain the primary objective, a modified nominal growth target can be used as a secondary input along with financial stability considerations.
It is important to recognise that the current economic slowdown is monetary-financial in nature and to that extent cyclical/demand-related. We’ve had a sustained period of high real interest rates combined with sluggish money supply growth. The final nail in the coffin came when the Monetary Policy Committee thought in July and August 2018 that inflation is likely to overshoot the target. Consequently, they increased the repo rates which resulted in a further increase in our real repo rates to 4 per cent levels. Soon we had the NBFC crisis trigged by the IL&FS episode and we are still picking up the pieces. Unfortunately, many believe that a mere 135 basis cut will be able to fix the situation. However, they ignore than inflation has averaged a 100-basis point lower throughout the year.
This means that real interest rates haven’t moved much while the real prime lending rates have gone up. If transmission isn’t happening, then we should expect aggressive front-loading of rate cuts with massive open market operations. India’s 10-year G-Sec yield is now higher than the latest quarter’s nominal growth rate.
The RBI governor mentioned he’s willing to do “whatever it takes”. He has to follow this up. The government for its part has to nudge small savings and deposit rates lower to help transmission. Our rupee debt being incorporated into global indices would help and so would the Indian government issuing dollar/euro bonds. We also need to give tax incentives for retail investors to buy government or other debt through mutual funds and exchange traded funds. We need all hands on board — now.
This article first appeared in the print edition on December 5, 2019 under the title ‘Case for a rate cut’. Gupta is a public markets investor and Bhasin is a Delhi-based policy researcher.