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Business News/ Opinion / Monetary policy responds to growth
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Monetary policy responds to growth

How much can RBI's monetary devotion help foster growth? Looking at the overall economic conditions, not very much

The overall monetary easing now, coupled with a marginal fiscal expansion, can only offer a little bit of impulse in these circumstances. Photo: Hemant Mishra/MintPremium
The overall monetary easing now, coupled with a marginal fiscal expansion, can only offer a little bit of impulse in these circumstances. Photo: Hemant Mishra/Mint

With mounting evidence of economic weakness, an easier monetary policy was widely anticipated by all. In lowering its policy rate by 25 basis points (bps), the central bank took note of the many adverse developments impacting growth, such as the slow global recovery, weakened exports, the 30 bps GDP downgrade (gross value added at basic prices) for 2014-15; the contracted foodgrains output from last year’s poor monsoon and more impact ahead from this year’s clouded outlook, the falling sales, profits and capacity utilisation in the industrial sector and the unclear signs of recovery in the services segment. Global demand is now out of the growth picture; the Reserve Bank of India (RBI) emphasizes that recovery ahead is dependent upon the ‘strengthening of domestic final demand’, i.e. consumer and investment spending, both of which remain feeble at this juncture. Indeed, it is hard to find any positives where growth is concerned in the RBI’s policy statement of 2 June.

It is somewhat ironic that in easing its stance, the central bank revised its inflation forecast for January 2016 - to 6% against 5.8% earlier due to higher monsoon risks and service tax hike – and lowered its growth projections for 2015-16 by as much – from 7.8% before to 7.6% now.

The rationale: front load a rate cut now to encourage a supply-side response over the medium-term that in turn, will help attain the end-point inflation objective of 4% in early 2018.

Against this monetary devotion to growth – three rounds of easing in less than six months this year, making it a cumulative 75 bps so far — is it appropriate to ask how much can it help foster growth? The sense is, looking at the overall economic conditions, not very much and with a considerable lag. Here are some reasons to make the case.

For one, this 75 bps easing now fully reverses the tightening that occurred over September 2013-January 2014. Those cues were hardly picked up by the banks then; just as they are unmoving in the easing round this year so far. That was, and is, telling. Balance sheet stress was considerable even then: evidenced by the mammoth debt overhang of many large firms; mounting bad loans and restructured assets and tapering credit demand. All these are even worse now and mirrored in the banks’ balance sheets. A lot, therefore, depends upon the credit demand-supply environment faced by the banks and their response to monetary signals.

The severe fiscal contraction that kicked in from the last quarter of 2012 continues to the present. A prolonged procyclicality of macro policies as it were, offering a glimpse into the kind of demand compression caused in order to bring down inflation. In conjunction with the balance sheet distress, demand is likely to take much longer to rebound from such a squeeze and present conditions: Consider the large slack observed from capacity utilisation levels and collapse in power offtake. The overall monetary easing now, coupled with a marginal fiscal expansion, can only offer a little bit of impulse in these circumstances; it is unlikely to lift spending, especially investments, in any meaningful measure. This isn’t to dampen sentiment, but only to highlight the distance between present demand conditions and the policies serving to boost them.

Renu Kohli is a New Delhi based macroeconomist.

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Published: 02 Jun 2015, 05:02 PM IST
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