The one thing that should prompt Raghuram Rajan of the Reserve Bank of India (RBI) to ease rates aggressively over the next few meetings is the fact that the Government's fiscal position looks extremely strong and the likelihood of meeting the fiscal deficit target comfortably is quite high.
RBI’s policy meeting on the June 2, 2015 becomes increasingly important in the midst of the developments in the domestic economy, the rupee movements as well as US Federal Reserve chief Janet Yellen’s assertion last week about going ahead with rate hikes so as to prevent future overheating of the American economy.
From my perspective two things are very clear. Firstly, the level of demand in the economy, be it from the consumption side or investment, continues to be subdued. Secondly, consumer inflation continues to be subdued and is likely to remain low given probability of lower food prices, low global commodity prices as well as the poor growth in consumer demand given high inflation of the last 5 years.
We have also had statements out of the ECB about frontloading the Bond Buying programme and aggressive easing from the Chinese authorities.
The corporate earnings season in India, too, has been quite subdued with results across the board showing slow recovery.
The one thing that should prompt Raghuram Rajan of the Reserve Bank of India (RBI) to ease rates aggressively over the next few meetings is the fact that the Government's fiscal position looks extremely strong and the likelihood of meeting the fiscal deficit target comfortably is quite high.
The possibility of an El Nino and the pressure on Indian currency are two things that will take precedence over other issues in Rajan's mind next week when he sits to take a decision on the monetary policy.
India Meteorological Department (IMD) has predicted a possibility of a poor Monsoon with more chances of below average rainfall. However, Skymet the private weather forecaster has a much better track record on the Monsoons over the last five years. They are forecasting not only a normal monsoon, but excess rains and a good spread to go with it. As such the inflation argument does not hold very well as CPI is likely to undershoot RBI’s forecast for January 2016.
The other things that could hold RBI back would be the possible pressure on the rupee. Although, by most estimates, the Indian rupee seems to be overvalued at this stage and this has led to a deterioration in the external trade position despite the fall in crude prices. Under these circumstances the economy actually needs a weaker currency in the near term. Export competitiveness has gone down substantially in many industries due to disproportionate INR strength.
Despite two rate cuts in the first quarter of 2015 we have not seen any significant translation of lower rates into the economy. The reasons for this have been twofold.
· High non-performing assets (NPAs) in the financial system which reduce the ability of banks to cut rates as repayments as well as interest payments for them continue to be slow.
· Inadequate action by the RBI to boost liquidity. RBI could have been more aggressive in mopping by foreign flows and releasing INR liquidity into the domestic economy. Otherwise it should have undertaken Open Market Operations (OMO’s) in the form of bond buying inorder to boost liquidity.
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Under the circumstances I would say that even RBI’s actions till take have been half baked. They have cut rates but have not found the conviction to take steps towards boosting domestic liquidity.
As I write this article, the liquidity in the system has started tightening again despite this being the lean season. It is time for RBI to step in aggressively to boost growth. It needs to upfront steps to take rates down in the economy. It can always step back later and not cut more if the inflation trajectory does not behave the way it should or the monsoons fail in such a manner that they lead to high food inflation. The behaviour of wholesale prices which continue to be negative indicate no pressure is likely to build on retail prices anytime soon.
The government has taken several steps on this front with both legislative action as well as onground activities. These should start showing up fromm September onwards.
In conclusion, Rajan’s aggressive action on inflation has led to greater confidence in the Indian economy. There has now been reasonable success on this front. Now it is time to act on growth and put the economy on a higher growth trajectory.
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