With the Reserve Bank of India (RBI) set to announce its annual monetary policy review on April 17, the question in everyone’s mind is whether the central bank would reverse its policy stance by cutting interest rates. In an interview with Parnika Sokhi, HSBC's Chief Economist for India & Asean, Leif Eskesen, says it will be a close call and RBI’s task of striking the growth-inflation balance is not easy. Edited excerpts:
The broad market perception is that the interest rate curve has reached an inflexion point, and reduction in policy rates is likely in the upcoming monetary policy announcement. What will be the central bank’s comfort in doing so?
I think it will be a close call for RBI next week, as one cannot make a strong case for rate cuts. There hasn’t been a substantial shift from inflation risks to growth risks since the last monetary policy meeting. Domestically, in terms of economic activity, there has been some moderation in overall growth. The inflation risks that RBI highlighted in the last policy meeting are still there. Oil prices have not eased to a large extent. Not only are inflation risks higher, but there are pressures on the current account as well. It would be a risky proposition to begin cutting rates is such a situation. To contain the pressure on current account, it is important to not stimulate domestic demand too much. I don’t think there is much room for rate cuts because of high inflation risks, maturity of credit cycle and slow progress on implementation of supply-side reforms.
RBI had highlighted the need for ‘credible’ fiscal consolidation in its mid-quarter policy review. Do you think what came out in the Budget for 2012-13 was up to the mark?
The Budget presented on paper did target fiscal consolidation and lower fiscal deficit, but we should also keep in mind that the fiscal outcome of the financial year ended March 2012 was much worse than expected. The fiscal situation right now is loose and is adding to inflation worries. It will be difficult to achieve the fiscal deficit target of 5.1 per cent; in our view it will be around 5.5 per cent. That means the ultimate reduction is not as much as needed. From RBI’s perspective, they are not getting enough help, although on paper they are moving in the right direction.
What are the prospects of growth in India? Where do you see the risks coming from?
India’s potential growth is not eight per cent any more, it is seven per cent. This is partly because structural reforms have not been implemented as fast as needed. That has held back investments. Last financial year, we expected growth to moderate around 6.7 per cent, while the government was saying 6.9 per cent, which is slightly below potential growth. So, there has been slowdown in potential growth while inflation risks are still high.
That is also a reason why it is so important for India to maintain the growth-inflation balance and a rate cut will not be able to deliver that. Since inflation risks are high and potential growth slow, inflation risks are going to snap back again. The key to lower inflation and improve growth in India is, clearly, implementation of structural reforms. It will be unfair to expect RBI will be able to pull this tradeoff all by itself.
Credit growth suffered in the last financial year. How do you see in the current one?
Overall credit growth has come down not only because of monetary policy tightening but also on account of economic slowdown. We are looking at relatively constrained credit growth, especially in the first half of the current financial year. It may gradually pick up in the second half. This is presuming there will be some rate cuts domestically and global economic conditions will improve.