Will RBI and FinMin work together to sustain growth?

The healthier HSBC Purchasing Managers’ Index (PMI) reading recorded on Wednesday is good news for the economy and, in particular, to those with long faces in corporate boardrooms.

But there’s an expected downside: many will now be wondering whether, with these improved figures showing a gradual turnaround in economic sentiment, the Reserve Bank of India (RBI) will wait and watch a little more until it starts actually cutting key rates.

The RBI, in its last policy review on 24 January, did not take any steps on the crucial repo rate - the rate at which it lends short-term funds to banks - but chose to attack the liquidity problem by cutting the cash reserve ratio, or the proportion of deposits the banks must park with the central bank, by 50 basis points. This makes more money available to the system.

But even as it cut the CRR, RBI governor Duvvuri Subbarao sounded a stern warning to the government for its fiscal profligacy and hoped that steps would be taken to address that issue in the forthcoming Union Budget.

The PMI figure - which is a measure of economic activity - stood at 57.5 in January, up from 54.2 in December. Expectedly, several sections have already declared this as the beginning of the return of good times.

However, there are other signals which indicate that the recovery - if one can call it that - is still rather fragile, PMI notwithstanding. A recent report in The Times of India, quoting separate analyses by Edelweiss Financial Services and CARE ratings, showed how corporate profits are still under intense pressure owing chiefly to two major factors - high input costs and higher interest expenses.

The report, quoting the Edelweiss analysis, said 51 of the BSE 200 companies posted a 26.5 percent jump in revenues for the quarter ending December; however, profit growth was just a mere 5.4 percent.

Another analysis from CARE Ratings , also quoted in the story, showed that while 444 companies posted a healthy jump in revenues and other income (27.7 per cent and 41.2 per cent year-on-year), expenses increased 33.1 percent faster than sales. Significantly, interest costs also doubled for these companies.

The banking sector, meanwhile, is keeping a close watch on restructured loans.

The country’s largest private sector lender, ICICI Bank, for instance, said its credit and deposits growth was healthy and profits were up 20 percent, but the bank did note there would be more loan restructuring efforts in the coming days.

The bank’s boss, Chanda Kochhar, said projects were taking longer to kick off and sanctions were slowing down. However, at a recent seminar, Kochhar also said the bank had been speaking to its 300 top SME (small and medium enterprises) clients and they were fairly optimistic about the economy.

She also pointed out that the government, however, would need to pick a few big projects and kick-start them to bring economic activity back on track. Investment, therefore, is the key.

Despite the clear message from the RBI that the real job now lies with the finance ministry in boosting investments, and given that the central bank is fast running out of options itself, Tushar Poddar of Goldman Sachs believes the central bank will cut both CRR and repo in the near future.

“Our GDP growth estimates remain at 6.9 percent year-on-year for FY12 and 7.2 percent yoy for FY13, " he said in a comment note.

“The RBI has also cut its FY12 growth forecasts to 7 percent from 7.6 percent – on the back of poor investment demand and slower global growth. On policy rates, the RBI has begun its rate cutting cycle by easing the CRR in its last policy meeting and we expect a further 50 bps of cuts in the CRR in 2012. We continue to expect that the RBI will ease the repo rate by 150 bps in 2012, starting with rate cuts in March.”

The Prime Minister’s Economic Advisory Council Chairman, C Rangarajan, however, says industrial output will pick up in the January-March period, primarily because coal output is up and inflation is down, according to a Business Standard report .

The report also pointed to continued expectations from finance ministry mandarins that a rate cut by the RBI would boost sentiment and growth momentum.

Does that mean the finance ministry will also be doing its bit in the Budget and then look for a further boost from the RBI? Or does North Block expect Subbarao to do most of the hard work himself?

The answer will lie in that black briefcase Pranab Mukherjee will carry to Parliament one crucial day in mid-March.