Credit for Raghuram Rajan's rate cut goes to Jaitley and his Budget
The task of regaining the lost momentum in the economy is with the government, not with the central bank
The larger share of credit for the surprise, quarter percentage point rate cut to 7.5 percent announced by the Reserve Bank of India (RBI) on Wednesday morning should go to finance minister Arun Jaitely than to governor Raghuram Rajan.
The RBI has largely reciprocated to the budget promises of Jaitely on fiscal consolidation, besides demonstrating its readiness to act under the proposed new monetary policy framework.
The stage was already set for a rate cut post the union budget, which largely promised fiscal prudence, but most economists had factored in the rate cut to come on 7 April since the February retail inflation numbers, due later this month, would offer a convincing picture on the inflation, especially food prices.
The trigger for Rajan’s surprise move, thus, has obviously come from the government. The evidence lies in the explanation Rajan has offered to cut rates, this time. There are four major reasons he has highlighted.
First, “The government has emphasized its desire to clean up legacy issues which gave a misleading picture of the true extent of fiscal rectitude, and has also moderated the optimism in its projections. To this extent, the true quantum of fiscal consolidation may be higher than in the headline numbers.’
Second, “Also, the government is transferring a significantly larger amount to the states, without entirely devolving responsibility for funding central programmes. To the extent that state budget deficits narrow, the general fiscal deficit will be lower”.
Third, “Furthermore, supported by lower international energy prices, there is a welcome intent to shift from spending on subsidies to spending on infrastructure, and to better target and further reduce subsidies through direct transfers."
Fourth, “the central government has signed a memorandum with the Reserve Bank setting out clear inflation objectives for the latter. This makes explicit what was implicit before – that the government and the Reserve Bank have common objectives and that fiscal and monetary policy will work in a complementary way.”
Under this, a joint monetary policy committee comprising RBI and government officials and external experts will set the inflation target. The government has already set a target of 4 percent for fiscal year 2017.
Finally, Rajan says: “In sum, then, the government intends to compensate for the delay in fiscal consolidation with a commitment to an improvement in the quality of adjustment.”
One could argue that it is bit early to buy the government’s promise on ‘quality” of fiscal consolidation since the roadmap laid out in the budget carries multiple favourable assumptions such as lower crude prices, the government’s own ability to roll out a successful disinvestment programme and the state of banking system in the country.
What is more surprising is that Rajan himself didn’t sound very convincing until recently about a full victory over inflation. To be sure, the consumer price index (CPI) inflation stood at 5.11 per cent, at kissing distance of the 6 percent upper limit projected under the agreement signed between RBI and finance ministry.
It was just a day before, Rajan himself said RBI is not in a position to cut rates “very quickly” as the inflation still remains high.
“Our problem is: we also have high inflation, we cannot cut interest rates very quickly to the bone in order to tell those countries -don't come here expecting high interest rates," the RBI governor said, addressing students in Mumbai on Monday.
Then why this cut today? As mentioned above, the primary push is from the government, which is increasingly worried about the faltering growth on the ground, something that doesn’t correlate with the image of a high-growth momentum in the economy the Narendra Modi–government is attempting to paint.
Rajan himself acknowledged the growth concerns as a reason for acting before the policy.
“The still weak state of certain sectors of the economy as well as the global trend towards easing suggests that any policy action should be anticipatory once sufficient data support the policy stance. Second, with the release of the agreement on the monetary policy framework, it is appropriate for the Reserve Bank to offer guidance on how it will implement the mandate,” Rajan said.
The growth across cores sectors has slumped as reflected in the recent data. There are no signs of strong revival as yet. The latest core sector growth numbers and HSBC PMI numbers corroborate this fact.
The PMI numbers released on Monday suggested the country’s manufacturing activities in February fell the lowest in five months on account of low output and absence of fresh orders. The index fell to 51.2 per cent from 52.9 per cent recorded in the previous month.
A look at the growth pattern of January core sector industries tell a similar tale. Out of the eight core sectors, only two — fertilisers and steel sector — showed some growth.
Growth in all other sectors dropped with natural gas registering the sharpest fall of 6.6 percent in January compared with a fall of 3.5 percent in December.
Growth in electricity and cement sectors slumped to 2.7 percent and 0.5 percent as against a growth of 3.7 percent and 3.8 percent in the preceding month, respectively. Growth in coal production plunged to a ten-month low of 1.7 per cent, even though that can be attributed to the current restructuring in the industry.
As Firstpost has argued earlier, the medicine for faltering economy cannot come from the RBI rate cut but it should trigger by higher public investment by the government.
Banks, which have been reluctant to cut their base rates, or minimum lending rates, even after the rate signals form RBI in January, might go for some amount of rate cuts this time. But any significant reduction is unlikely given that business situation hasn’t improved on the ground and banks are neck-deep in bad loans.
As the economic survey pointed out, the task of regaining the lost momentum in the economy is with the government, not with the central bank. That said, today’s rate cut can surely act as a sentiment booster.
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