Jaitley's optimism vs RBI's caution: Why FM should read rate panel's minutes closely

No one likes a pessimist, particularly so, in an economy that is desperate for an image makeover. But in the Mint road, where the contours of the country’s monetary policy are framed, there are a few of them around. At least, that is the sense one would get looking at the minutes of the technical advisory committee (TAC) of the RBI on monetary policy. There is visible pessimism among the members at the Reserve Bank of India (RBI) on the current growth scenario. The members of the TAC, which advises the RBI governor on possible actions in the monetary policy, clearly observed that domestic economic activity was weak, ahead of the June 2 policy review, the minutes show. [caption id=“attachment_2310336” align=“alignleft” width=“380”]  PTI[/caption]The TAC is specific on elements that has contributed to their pessimism — slowing consumption demand and continuing weak non-food bank credit growth, which can potentially slowdown pace of economic turn-around, something Rajan himself highlighted in the 2 June policy and in the presser that followed. “We are under no illusion that the economy – especially investment – is up and running. It is not. It needs support,” Rajan said. “We are trying to use whatever room we have to undertake measures that revive the economy.” The TAC minutes, released on Tuesday, repeated the warning. Its members noted that the initial optimism (after the Narendra Modi government came to power) regarding growth and investment was waning, corporate earnings are subdued, growth in industrial production was muted, investment indicators showed no sign of turnaround, credit expansion was yet to pick up, manufacturing growth was at a five-month low and exports were declining. To be sure, in April, the factory output numbers showed some recovery. To cut a long story short, no one in the RBI seems to admire the bullish picture painted by government’s statisticians using the re-based GDP numbers, at least for now. Instead, there were cautions to the government to act urgently to address the concern of waning investor optimism in the country. The TAC has called for realistic assessment of the economy. That is something, which prompted Raghuram Rajan to go with the recommendation of the panel (a rare instance when Rajan has done so) and cut the repo rate by a quarter percentage point to support to the faltering economy, even when celebrations were on in the North on the 7.5 percent GDP growth. Time and again, the RBI has raised its doubts over the new GDP numbers. “In the eyes of the rest of the world, it is a discrepancy why we feel the need for rate cuts when the economy is growing at 7.5 per cent. Most economies growing at 7-7.5 per cent are just going gang busters and the issue there would be to restrain rather than accelerate growth,” Rajan said on the policy day. Another notable point in the TAC minutes is that there was a widespread view that inflation is somewhat a contained danger, even though there are clear upside risks pertaining to price trends, mainly arising out of impact on crop production and pick up in oil prices. According to the minutes, all seven external members of the RBI committee recommended a reduction in policy repo rate – four members advocated a cut by 25 basis points; two members suggested a 50 basis points reduction and one member proposed a reduction by 75 basis points. The members who had recommended a reduction in the policy repo rate by 25 basis points were of the view that notwithstanding risks to inflation from monsoon and oil prices, sharp reduction in inflation warrants a reduction in policy rate when consumption and external demand were weak and investment was showing a potential to revive. It would, perhaps, be useful for Arun Jaitely to heed to the warning signals from the central bank, understand the faulty areas and work to resolve them. In the policy, Rajan had very clearly illustrated what the government needs to do to rejuvenate growth in the economy — step up public spending and urgently recapitalise the country’s banks. There are no other short-cuts. This is something the economic survey too pointed out as a prerequisite to revive growth. After the RBI officially took up the matter of bank recapitalisation, the government has showed some willingness to increase the quantum of funds to be infused in the public sector banks. The government had earlier allocated just Rs 7,940 crore in the union budget for select state-run banks, while others were asked to raise money on their own. But the government is now forced to rethink on the capitalisation strategy after warnings from the central bank. One of the major reasons for absence of any major pick-up in credit growth is that most state-run banks are sitting on huge stressed assets. This has increased their requirement for capital and constrained their very ability to use funds for credit expansion. The government will have to keep feeding banks until the time it is ready to let go of their control and let private capital come in. Adequate recapitalisation of banks, coupled with a pick-up in public investments, can get the economy back on the growth trajectory. At least, that is what the Mint road seems to believe.