RBI's next cut depends on deficit control by govt: ICRIER

Dr Shankar Acharya of ICRIER believes the Reserve Bank will wait on the government to make good on its promise of containing the fiscal before it goes ahead with another repo rate cut. “I think we probably should not expect a whole slew of ongoing cuts in the repo rate unless and until you get the required action from the government’s side on fiscal policy,” he said.

The fiscal situation in the country is one factor that could have a significant impact on inflation, especially if the government doesn’t move on containing subsidies to the levels indicated in the Budget. “And they can only be so contained if the required price increases in petroleum products, fertilizer, etc are put through,” added Acharya.

He goes on to say that if there were to be further rate cuts, they will come only post June, which is when the government will decide its next step on the path to fiscal consolidation.

Below is an edited transcript of his interview with Udayan Mukherjee and Mitali Mukherjee. Also watch the accompanying video.

Q: What did you take away from the Reserve Bank’s communication? Do you think the economy should expect many more rate cuts going forward and what would it do in your eyes to restock the investment cycle?

A: I read the RBI’s communication as a nuanced one. Given the recent trends in growth, industrial production and of course inflation, as reflected in the WPI and particularly core inflation, they did see an opportunity to reduce the repo rate for the first time in three years. As you know, they went ahead and did it by 50 basis points.

However, I think they correctly pointed out various upside risks to inflation which exists in the system. They also clearly indicated that amongst those upside risks, fiscal pressure from the government’s side is a very serious one, especially if the major subsidies are not contained to levels indicated in the recent Budget. They can only be so contained if the required price increases in petroleum products, fertilizer, etc are put through.

So against that background, I think we probably should not expect a whole slew of ongoing cuts in the repo rate unless and until you get the required action from the government’s side on fiscal policy. I think in that sense what happens is in May, perhaps early June, very important with respect to the listed prices on petroleum products and so forth. Until then, I would very much doubt if there is any further action on repo. What happens in July will depend on what happens on the government action side in between developments on inflation growth and so forth in terms of the available data.

Q: Would you say the action that we saw from the Reserve Bank is enough to get translated into a big rate easing cycle in the larger system or will that still remain quite tight?

A: I think it’s probably too much to expect one such reduction to immediately have the kind of impact some of you maybe looking for. I think we would have to see more evolution of policy in this regard. I would like to point out that when we talk about repo rates and so on, that’s an overnight rate. Of course it has an impact, but we should also be concerned about the long term rates on risk free bonds and notably things like 10 year treasury and so forth. The rates on that are determined by what’s happening with respect to government borrowing, in particular the market borrowing program which is intermittently linked scale of the fiscal deficit.

As you know, the Budget itself talks about a market borrowing program in net terms of close to Rs 500,000 crore and that’s the biggest we have ever had. So accommodating that is going to be quite a challenge, and doing that without further increases in the long term 10 year treasury benchmark rate is also going to be a challenge. So I don’t see that coming down in a hurry.

Against a background where the long term interest rates are not moving down, essentially for government borrowing being very large reasons, I think that limits what happens to the overall structure of interest rates no matter what you choose to do at the very short end of the repo.

Q: Many analysts believe that the Reserve Bank, maybe with an eye on growth or because of some political persuasion, might have moved too early on inflation without having won the victory on inflation by any distance. Do you think inflation is still too tricky to call?

A: The Reserve Bank itself in its documentation makes it very clear that the inflation victory has not yet been won, but rightly they don’t treat inflation as a sole objective of monetary policy. There are other objectives such as financial stability, such as level and growth of economic activity and so forth. I think they have been rightly concerned by what is been happening on the growth side, both industrial and overall growth, and so it’s a very difficult kind of balancing act that they have to perform.

I don’t think anywhere in their documentation they have claimed that nobody worries about inflation any more in the RBI. On the contrary, I think they have pointed out a whole slew of upside risks I just mentioned earlier. Suppressed inflation, because various administered prices haven’t been increased and so forth, what might happen to international commodity prices, oil and so forth and whole range of other things.

So I don’t think that they are in any sense out on a limp as far as inflation is concerned. They are taking a balanced view, they see a reason for doing a cut. Remember this is after three years of essentially a rising and then a pause. So they are saying that further cuts will depend on a whole slew of factors including in particular sensible action on the government’s fiscal side.  I don’t have a problem with that.

Q: For global, country and market watchers, the singular concern still seems to be the poor quality and rate of growth itself, not so much what the Bank is up to. They seem to suggest that this kind of growth will not take India anyway near the big ‘developing country to watch out for’ status. Would you say that remains an uphill task as well, what we do on the growth parameter itself?

A: The growth parameter is an outcome as you know; it’s an outcome of lots of things and of course that is a big worry. All well know that for five years we had an average growth of about 9% between 2003 and 2008 and we are now down to somewhere in the 7% level. I think the Reserve Bank itself for this fiscal year is talking about a little above 7% as their central projection and the government has talked about 7.6%. In my view, both those are probably a little on the optimistic side. I think we are likely to see growth more in the range of just 7% or maybe even little below that.

But these are not big differences, so I don’t want to go to town on that. I think you are quite right that the real issue is not just what happens to growth in 2012-13. The real issue is what the trajectory of growth is in the three or four years ahead. The approach paper of the 12th plan talked about 9% growth for the five year period from 2012-13 on. But is that on the cards still?

Frankly, my view is no, partly because of what’s happening in the international world. But mainly, I think we have lost the plot in terms of government policy here in terms of investment climate, fiscal policy, reforms so on and so forth. Unless you have a serious change of those dimensions, I really don’t see growth going back to the 9% kind of story again in the coming three or four years. Of course if it happens, it will be wonderful. But it won’t happen by itself. It does require very deliberate action, very politically sometimes difficult actions on a whole range of policy issues, fiscal reforms, investment climate.