RBI policy: Not rate cut but Raghuram Rajan will be the highlight this time

The obvious question tomorrow (Tuesday) when Reserve Bank of India (RBI) unveils its bi-monthly monetary policy is this. Why does the world’s fastest growing economy (which grew 7.6 percent in the fiscal year 2016 and 7.9 percent in the fourth quarter) need a rate cut boost? If one believes the Gross Domestic Product (GDP) numbers, the economy is anyway expanding at an enviable rate and it doesn’t need an additional doze of rate cut right now.
Contrary, there are reasons for RBI governor Raghuram Rajan turn wary on the consumer inflation front.

 RBI policy: Not rate cut but Raghuram Rajan will be the highlight this time

RBI governor Raghuram Rajan. File photo. Reuters

The latest consumer price index (CPI) inflation for April showed a growth of 5.4 percent compared with 4.8 percent in March. Although one could argue that CPI inflation has largely come down from the near double-digit levels and will ease further on the back of a strong monsoon expected this year, there is uncertainty looming still. Good monsoon is still a forecast, not a reality. The RBI would want to wait and see to what extent the prediction comes correct.

For the time being, the consensus is that the RBI is likely to hold the key policy rate at 6.5 percent.

But, Rajan can surprise with a 25 basis points (bps) rate cut giving the following reasons.

One, growth isn’t really picking up on the ground yet no matter what the GDP numbers shown and no matter whether we are the world’s fastest growing economy or not. The Nikkei/Markit India Manufacturing Purchasing Managers' Index (PMI) - a composite indicator of manufacturing sector performance - showed that the Manufacturing output in India grew at its slowest pace in five months in May, suggesting that the sector is "barely improving". The index stood at 50.7 in May as against 50.5 in April - one of its lowest readings since the end of 2013. It’s a reason to worry on growth and cut interest rates.

Two, credit growth for the industry, an important indicator for economic revival, is not picking up anywhere. According to latest RBI data, the credit growth to industry increased by just 0.1 percent in April 2016 compared with the increase of 5.9 percent in the corresponding period last year. If growth has picked up at a faster pace, why it is not reflecting in the industry growth and their funding pattern? That’s another reason for Rajan to cut rates to support growth.

Three, the Centre for Monitoring Indian Economy (CMIE), a trusted name in economic research, has pointed out that Indian economy actually grew by 5.2 percent in the fiscal year ending March 2016 (as against the 7.6 percent showed by the CSO) as compared with 7.1 percent in the preceding full fiscal year, if one excludes the ‘discrepancies’ component in the GDP measure. As this article, explains the larger the “discrepancies,” the more worried one is likely to get about the veracity of production side GDP.

In other words, Prime Minister Narendra Modi has highlighted the government’s GDP figures during his ongoing foreign trip which something the CMIE has been disputing. If the RBI chooses to dismiss the 7.6 percent figure and observes that there are issues on the growth-front, it will have reasons to cut the policy rate tomorrow. Such an observation from the central bank will be an egg on the face of the government.

It’s not about policy alone

More than the RBI policy, what will be central to the discussions tomorrow at the central bank will be Rajan’s continuation at the central bank post September. That whether he chooses to respond to BJP leader Subramanian Swamy’s charges in the post-policy presser and gives any clue on his continuation in office will be watched closely. There aren’t two opinions on the fact that Rajan reinstated the credibility of the central bank and the monetary policy in the financial markets. For the same reason, his exit is due to have a short-term impact on the markets and among global investors. On matters of economic stability, investors trust the central bank of a country than the government.

Rajan has played a key role in modernising the monetary policy process in India and in overhauling the banking industry structure by way of several carefully calibrated moves with the help of his trusted lieutenants such as deputy governor Urjit Patel and central board member, Nachiket Mor.

Rajan’s biggest achievement is binding the government under an agreement on inflation targeting through a monetary policy committee, thus making it as a joint process not a one-man show of the RBI governor as it used to be for decades. When Rajan is nearing the end of his three-year term, the inflation is under manageable levels, the rupee is more stable an the country’s foreign exchange reserves are in a much better shape than it was three years back.

Modi would do well if he gives a second term to Rajan for the simple reason of ensuring reforms continuity in the economy. The PM should ignore the dissenting faction in the BJP led by Swamy. There aren’t many who could fill Rajan’s shoes. The highlight of the policy tomorrow will be not the rate cut, but cues from the governor on whether he will stay or not.

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Updated Date: Jun 06, 2016 12:52:00 IST