A question to Arun Jaitley: Does an economy growing at ‘very good’ pace really need a rate-cut boost?
If demonetisation has not impacted growth seriously, as Arun Jaitley claims, and the economy is doing well, what is the need to put indirect pressure on the Monetary Policy Committee to cut rate?
Union Finance Minister Arun Jaitley wasn’t shy to open his heart and express the wish that a cut in interest rates from the MPC (monetary policy committee) at its review this week could be of help to India’s economy in the current economic scenario. In an exclusive interview to CNBC-TV18 , FM Jaitley also listed the reasons to support his argument.
“Inflation has been under control for a long time. Don’t expect the crude oil prices to go through the roof. Any FM in the current scenario will like a rate cut. But await MPC’s decision.” This is, perhaps, for the first time since MPC -- the new institutional framework agreed by both the government and RBI -- became functional about a year back, the government is giving ‘clues’ to the rate making panel what it wants, explaining the rationale to argue why a rate cut is the correct decision at this moment. Under the agreed structure, the MPC has an inflation target of 4 percent, upper tolerance level of 6 percent and lower tolerance level of 2 percent. Jaitley is right in a way since inflation has been easing for some time. In April, the CPI fell to 2.99 percent inching closer to the lower band.
But, the problem with the government openly expressing their ‘likings’ and ‘wishes’ is that it tends to put pressure on the monetary policy authority while doing its job. This used to be the case in the UPA era when Pranab Mukherjee was holding the finance minister's post, it has happened when P Chidambaram was in office -- remember his comment, “if the government has to walk alone to face the challenge of growth, then we will walk alone”? In fact, Jaitley is right when he says any FM would have preferred a rate cut in the current scenario for the reasons he listed. In fact, any FM would want an RBI rate cut in any scenario because growth is the primary concern of a political leadership while for the central bank, it is price stability.
But, the surprising factor here is that Jaitley himself doesn’t believe there is a problem with economic growth at this point. Just last week, when the CSO released the January-March GDP/GVA figures that showed a sharp slowdown in the country’s economic growth on account of a slew of factors including demonetisation, Jaitley discarded the critics saying that a 7-8 percent is ‘fairly reasonable level of growth by our own standard and very good by global standard’. India grew at 7.1 percent last fiscal year and at 6.1 percent in January-March period.
The question is why the economy which has already achieved a ‘fairly reasonable’ growth according to Indian standards and ‘very good’ growth by global standards needs a rate cut boost at this point? If demonetisation has not impacted growth seriously, as Jaitley claims, and the economy is doing well, what is the need to put indirect pressure on the rate panel for a rate cut, listing out the reasons and logics? Doesn’t that amount to undermining the independence of the MPC, which has a constitutional right to act, to fulfill its mandate on keeping inflation under check? Remember, Jaitley’s comments on MPC rate cut is coming just two days ahead of the RBI rate announcement on 7 June.
Whether a rate cut alone will benefit the economic growth is a matter of larger debate. The theory that advocates a lower lending rate translates into higher credit growth to industries and helps growth, hasn’t really worked in the past. Bank lending to industry has almost come to a standstill for a long period now and the reason for this is not really high interest rates but poor demand from corporates (slow economic activities) and huge amount of bad loans on the balance sheets of banks. Unless this problem is addressed, a rate cut wouldn’t do much help to support the economic growth beyond adding positive sentiments. Banks too will be reluctant to cut rate further and take further credit exposure when these entities are already fighting a bad loan crisis. Also, there is a risk of capital flight in lowering the interest rates when the US Federal Reserve is slowly lifting the rates.
Probably, what made Jaitley argue in favour a rate cut ‘in the current scenario’ is his realisation that the economy is not doing all that well despite his insistence to the contrary. A closer look at the January-March numbers show that except for government spending and growth in agriculture (thanks to good rains last year), there has been no major segments that have shown promise. Construction, services, manufacturing and gross fixed capital formation — all have shown a disappointing picture. If one leaves out public spending and agriculture, then GVA growth plummets to 3.8 percent in the fourth quarter, compared with 10.7 percent in the comparable quarter last year. Such a fall is enough to scare any government about the growth scenario and look for remedies.
The bottomline is this: As Jaitley points out, a slowing economy is a result of several factors and one needs to deal with it. A slowing economy is not a sin but a situation to deal with addressing the specific issues. But the finance minister would do well acknowledging the problem first instead of painting a rosy picture and making a case for an indirect stimulus.
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