The raison d’etre for reduction in the cost of credit or interest rate structure lies in the revival of the growth process in the economy. The context for the October-end monetary policy announcement is indeed very different from the earlier ones. After a period of policy inaction, several measures have been initiated on the fiscal side. These signals coupled with the reform announcements in areas like foreign direct investments, the virtual postponement of GAAR (general anti-avoidance rules) and retrospective taxes have increased the level of confidence in the economy. This is getting reflected in the increased inflow of foreign funds. These inflows on the one hand help in mitigating the impact of a yawning current account deficit and strengthen the rupee, and on the other hand can provide the required firmness in the capital market. The last factor, that is buoyancy in the capital market, is critical for reinitiating the disinvestment process. While steps have been initiated on the fiscal side without a coterminous monetary policy, it would be difficult to revive the expectation of a 6%-plus growth. From the industry’s point of view, this is particularly important as industrial production growth in April-August period was only 0.36% over the same period last year.
The concept of reviving investment for growth is often misunderstood; it is felt that without administrative and legislative changes that include land acquisition, environmental clearances, forest area clearances, etc., the investment cycle cannot be revived. This is indeed true for large infrastructure, mining and industrial projects; however, these apart, there are numerous brownfield projects and small and medium greenfield projects that do not require large pieces of land or get held up for environmental clearances. Many of these projects, which could be belonging to small, medium or large firms, have been shelved purely for financial reasons.
The high cost of credit in a deteriorating-demand scenario is a key factor. Second, higher interest rate in conjunction with higher cost of raw materials had brought about deterioration in the margins and overall profit.
Two developments are important here in the context of inflation. First, the international price of raw materials, particularly metals like aluminium, zinc, copper, and iron ore, are dropping since the third quarter of 2011-12, and in view of the slowdown in the Chinese economy this trend is likely to continue. The prices of coal, thermal coke and crude are also showing a decelerating tendency. With the strengthening of the rupee the beneficial pass-through impact of these developments on inflation would become visible.
However, in our case, fuel and power prices are partially administered; the year-on-year increase in this category in September was 11.9% post the diesel price hike. Interestingly, non-food manufactured items (core inflation) was basically unchanged at 5.55%. This de facto indicates that non-food manufacturing sector has to absorb the additional transportation cost. Given the competitive conditions in the economy, it is difficult for core inflation to pick up. So far as food inflation is concerned, apprehension of a poor monsoon is behind us. In fact, with moisture in the land during the current rabi season could be even better than the previous one. The apprehension of post-harvest pressure has already started softening the futures price of agri commodities.
RBI has been holding on to a high repo rate for too long. At a time when measures have been initiated on the fiscal side to keep the deficit under control, and when the government through its reform-related announcements is trying to create a certain level of confidence among investors, one would expect that RBI will not surprise us with its ambivalence. Demand cannot be revived without a sharp reduction in interest rate structure. Shrinking demand is reflected in the poor industrial growth of 0.36% in the April-to-August period and the 9% year-on-year drop in non-oil imports in the April-September period. In view of the lag that exists between repo rate reduction and its transmission through the economy, an immediate reduction of 50 basis points in the repo rate is called for. Over a period of one year at least 100 basis points reduction would be necessary.
(This is the fourth in a series of five articles ahead of the Reserve Bank of India’s second quarter monetary policy review on 30 October.)