There is a general expectation that the Reserve Bank of India will cut rates in its mid-quarter policy review. This time, RBI is expected to soften stance on weak industry growth in April which was flat at 0.1%. However, economists feel that the central bank may not continue slashing rates further from now.
Shankar Acharya, ICRIER warns that there are no prospects of softening in rates in long and medium-term. He reasons that fiscal reforms are critical to ease inflation and increase growth. RBI’s monetary stance is being blamed for creating tight monetary situation in the economy, leading to a slowdown in the fourth quarter (FY12) GDP growth.
Acharya argues that government’s borrowing requirement continues to be high and will remain in the state through FY13. He also warns that possibility of growth below 6% in FY13 cannot be ruled out.
Below is the edited transcript of his interview with CNBC-TV18's Latha Venkatesh and Ekta Batra. Also watch the accompanying videos.
Q: What is your sense in terms of the growth inflation balance? Do you think that the bad growth numbers that we got are bad enough for monetary policy to ease at this point in time or do you think that we still need to keep a hawk eye on inflation?
A: I think RBI must be in a bit of a tough cleft stake position, having to make a very difficult decision, because inflation is still at levels which are uncomfortable. There are possibilities of it increasing because of recent depreciation of the rupee and ofcourse if they get around to adjusting diesel, LPG, fertiliser prices. That seems to get postpone all the time. So, those are reasons why we are not in a comfort zone on inflation. Clearly, we are not on a comfort zone in growth either.
The other thing is that a lot of market participants and analysts are saying ‘now that you had the IIP data for April showing zero growth practically and another bad outcome on the capital good side and so forth, the RBI must act to further reduce the repo rate.’ Now the question that I would ask is, ‘do people really think that will have a significant effect?’ If the borrowing requirements of the government continue to be at a very high level not only as they were programmed in the Budget, but in the absence of adjustments for petroleum prices and fertiliser and food, these will presumably continue to rise over the year. Revenues are unlikely to make up, given that growth has slowed probably to levels lower than anticipated at the Budget time. So, against that background that the borrowing programme of the government will continue not only unabated, but perhaps heightened, what will be accomplished by whether it’s a 25 or 50 or even a 100 bps reduction in the repo rate? I mean you might get a temporary upward flip in the stock market and stuff like that. But in terms of its overall impact on larger macro economic activity like investment and so on, it’s a question mark.
Q: Going by what you are saying that even if we do get any kind of a monetary loosening, on the ground the situation does not change. Is it fair to say that 5.3% GDP that we got in Q4, number, which is similar to that maybe extending upto 6%, is likely to continue on to FY13 because monetary policy loosening is not helping and the government has not acted at all since the Budget? What is your expectation of how growth will pan out for India then?
A: This is always a guessing game. A lot will depend on what is happening outside of India certainly. But within India, I am afraid policy seems to be really not moving. While there are a lot of press conferences and so on about projects being put on a fast track and so forth, I am not sure what is the great deal is actually happening on the ground. But then I really do not know the details.
A few months ago, I thought that growth this fiscal year would be in the band of 6% to 7%. I hope that would be closer to the upper side of that band. Now, I have to say that my expectation is that it will be at the lower side of the band. If the monsoon’s don’t do well, of which now there is a substantial possibility, though not a clear certainty obviously, therefore agriculture does not do well then there is some chance that growth this year could dip below to 6% for the full year. But these are early days in the year. So, one should not be very clear on this.
Q: One hypothesis that has been doing the round is that we were not inherently an 8% to 9% country at all. That happened because of international exuberance and cheap capital movement from developed countries. Now with that impact getting shaved off, we are back to our ‘90s growth pace of perhaps 6%. Is that a hypothesis you would subscribe to?
A: Partially. If the international environment is supportive, in the sense of being booming away happily, it clearly helps all countries. A rising tide lifts all boats. So, clearly that is the case. I think that may account for 1-1.5%. So, instead of 9-9.5%, we could have dropped to 8-7.5% or so. But I think any further reduction beyond 8% to 7.5% is really all our own doing.
I would say that perhaps more than half of deceleration that we have seen in the last 15 months or so from 9% plus to just over 5%, over half of that deceleration is due to our problems, things that we have not done or things that we have done badly. In that sense, I only subscribe partially to that hypothesis.
Please remember that even in the hay days of our boom, 2007-2008, when we were growing above 9%, the actual reliance on foreign capital inflow in the net term, from foreign savings point of view, was just over 1% of GDP. Our domestic savings were high just as our domestic investments rates were high both one was over 38% and one was 37%. So, it was not as if we were hugely reliant at that time on abundance of foreign capital, clearly the fact that you had a global liquidity boom contributed to easy money conditions, but I don’t think they were central to the Indian growth performance.
Q: After that IIP number, which is a really bad data, we were doing the math after the detail numbers came out. If you took out one product, rubber insulated cables contracted by 85% year-on-year. If you remove that item then capital goods from becoming -16.3% actually becomes + 10.6% and IIP itself from 0.1% goes up to 3.6%, so really shaky numbers out there. But in any case, we have those growth numbers with us. The market is running away after those numbers with an expectation that perhaps the RBI should or will cut both the CRR and repo by maybe 25 basis points. Something stronger than 25 basis repo cut is getting factored in or is being talked about by several market participants. What is your comment or your expectation?
A: I have already in a sense commented on that. I know that market likes this repo rate reduction. But the repo rate is the overnight rate. I see no prospects of softening on medium and long-term rate because of government’s borrowing programme associated with a large and possibly rising fiscal deficit. So, against that background, to me, the logic of undertaking cuts in the overnight rates or so called policy rate, there is a question mark.
You might send a signal, which is positive, at a time, when there is lot of gloom and doom around. So, I wouldn’t say it’s obviously wrong, but it is little like pushing on a string. So, other than temporary jumps in the equities market and so forth, I don’t necessarily expect a huge lot to change on the ground, if that is done.
Q: If the Finance Minister becomes the President as is being spoken about or atleast a majority of the people on the street believe that that’s a distinct possibility, then from an economic point of view, with respect to reforms, who, according to you, perhaps will be best placed to take on the mantle of the Finance Minister? Everyone is pinning for some hope of reforms after the Presidential election.
A: At my reading of the situation over the last few months, perhaps even a couple of years, is that the so-called stasis on economic policy and on reforms and on so-forth is not so much because of faulty analysis, though there maybe some of that, but rather much more because of political strength, political co-ordination, political will, whatever you want to call it. So, from that point of view, if one thinks that that assessment is correct then it is not that one is looking for a technical wizard in becoming a Finance Minister, it’s more a case of the overall governmental set-up, which means the political leadership. In that, you have to count the Congress President.
Having what it takes to bite various bullets, but the bullets has been identified for quite a long time. You have to do something serious on these prices adjustments, you have to send some reform signals, you have to get on with projects which are stuck in various important infrastructure sectors. So, all these bullets are very well-known. It doesn’t require any kind of rocket science to identify them. So, from that point of view, a particular person is not necessarily the issue, though obviously you want some experience.
Q: You correctly pointed out that fiscal deficit has been the big elephant in the room. That becomes a cause for inflation as you point out. What are the chances that we might get back into the 90 syndrome of growth being around 5-6%, but inflation being at close to double digits maybe 8-9% and not climbing down. In other words inflation being distinctly 2-3 percentage points above growth. Is that a medium-term scenario at all for you?
A: It’s a possibility. If we continue the way we are going, it’s a possibility. If we continue to have policies, which are not sound then we will get outcomes which are unhappy. So, I do not think there is any mystery about this.