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Wednesday, 01 June 2016

Monetary placebo

Rate cuts won’t revive India’s stalled growth

India’s latest interest rate cut won’t revive growth. The central bank’s quarter-percentage point reduction in the policy rate, to 7.75 percent, is just as futile as the last one almost a year ago. GDP will pick up when New Delhi curbs its own profligacy and improves the investment climate. The February budget may be the current government’s last chance to do both.

If companies aren’t investing, it isn’t because monetary policy is too tight. With 10.6 percent consumer-price inflation, the base rate for borrowing in 10-year bonds was already negative in real terms before this last rate adjustment. Rather, the government’s quest to fund itself is crowding out the private sector. Banks are forced to buy up government bonds, meaning two-thirds of what households save in a year is reinvested in public debt.

Bottlenecks choking growth are also in need of attention. A debilitating coal shortage is hurting electricity production. Meanwhile, road builders are wriggling out of contracts with the highway authority on the pretext that the environmental clearances promised to them are taking too long to materialize. Such factors help explain why GDP growth for the financial year is expected to slow to a ten-year low of 5.5 percent.

Deep interest-rate cuts are currently impossible because of inflation. Rural wages are rising at an annual 18 percent pace. If more money isn’t matched with greater investment and output, the result would merely be a further boost to imports, widening India’s 5.4 percent current account deficit. For now foreign investors are helping to finance that through their purchases of Indian stocks and bonds, but it would be unwise to rely on that, especially if India’s broader economic improvements don’t take hold.

Growth thus depends on what New Delhi unveils in February. Finance minister Palaniappan Chidambaram has promised fiscal consolidation and other reforms. If he avoids the temptation to indulge instead in vote-buying populist measures that increase the government’s spending commitments, there may be hope not just of another rate cut, but of a recovery too.

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The Reserve Bank of India cut its policy interest rate of 8 percent by a quarter-percentage point on Jan. 29, the first reduction since April 2012. To ease liquidity conditions, the monetary authority also pared the ratio of deposits banks are mandated to keep with the central bank as cash by a quarter-percentage point to 4 percent.

In its quarterly review of economic and monetary developments, the central bank said that an improvement in investment climate is a “prerequisite for economic recovery” and that the “quality of fiscal adjustment remains a concern.” Risks remain from “suppressed inflation, pressure on food prices and high inflation expectations getting entrenched into the wage price spiral,” the monetary authority added.

While demand conditions are “tepid,” a current account deficit of more than 4 percent of GDP for a second straight year makes it necessary for the authorities to remain prudent while stimulating aggregate demand, the Reserve Bank said.

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