Another hike will impede India’s growth story, but inflationary impulses in the system still need attention.
Chairman, RPG Enterprises
Another rate hike now can seriously jeopardise investment plans of companies and impede the strained growth momentum
All eyes are now on the Reserve Bank of India (RBI) as the mandarins of Mint Road get down to deciding on the next course of action on the monetary policy front on September 16. The jury is clearly out on whether the central bank will raise rates once again, after the aggressive 50 basis point (bps) hike in July, or whether it will finally press the pause button, choosing not to disrupt the growth momentum any more.
Despite those who continue to argue in favour of a further hike in rates, perhaps in the region of another 25 bps (something that many have even factored into their calculations), I am strongly of the view that it is now time for RBI to press the pause button.
And I say this for a variety of reasons. Let us first consider the latest GDP figures that have been released, and the signals from that. The first quarter GDP figures for FY12 came in at 7.7 per cent, a shade below the previous quarter’s figure of 7.8 per cent. Those arguing in favour of another quick rate hike may argue that this demonstrates the economy’s resilience despite the earlier rate hikes and the global economic situation.
However, I believe that this is not a complete assessment of the situation. The emerging global scenario, in which the largest and the mightiest of economies are struggling with the possibility of a double-dip recession, and the visible strains on domestic demand, are ominous. Add to that the fact that, typically, policy action from RBI always comes with a lagged effect and you have a situation in which growth is expected to be lower in the next few quarters. Another rate hike now can seriously jeopardise investment plans of companies and impede the strained growth momentum.
More From This Section
A closer look at the GDP figures also points to the fact that growth may be resilient on the surface but cracks are beginning to appear in some segments. For instance, the construction and mining sectors registered serious drops of 8.6 and 10.3 per cent on a quarter-on-quarter basis, respectively, and the coal sector has also been disappointing. Although the manufacturing sector continued to be healthy, the next few quarters will undoubtedly impact this as the previous rate actions take their effect and demand will slow down. The worrying factor for corporate India is the slowing of private consumption, which fell to 6.3 per cent year-on-year against eight per cent year-on-year in the earlier quarter.
On the RBI side, I am of the view that the central bank has so far been keen on staying ahead of the curve in tackling inflationary pressures, given the lack of adequate support on the supply side. It is perhaps with this in mind that the central bank raised rates aggressively, and in particular in July, when most of us had been expecting a hike of around 25 bps. With the 50 bps surprise increase, RBI may have placed itself in a more comfortable situation now, and should finally have the little luxury of a pause this time round. And though inflation still rules at around 9.2 per cent, it is showing some signs of easing, if viewed against the June figure of 9.4 per cent year-on-year.
From an industry perspective, I strongly feel there are serious challenges corporate India is facing on several fronts. Though input prices have come down a little after the global turmoil following the Standard & Poor’s downgrade of the US ratings, there is no certainty that this will last for the next few quarters. Alongside, serious demand constraints globally and domestically (the auto sector numbers are a pointer) can prove to be enough for corporate strategists to get back to their drawing boards.
I feel yet another rate hike by RBI at this point, when industrial growth is under serious strain and global headwinds are gathering momentum, can be a major hindrance to the India story that has so far managed to sustain itself despite severe challenges. A good monsoon and slightly easier input prices may actually help the growth momentum to continue and so, this is surely not the time for yet another rate hike.
It is time for a pause. To take stock of the unfolding situation. And then decide the future course of action. One more hike could be a recipe for disaster.
Senior India Economist, JP Morgan
It is irresponsible for a central bank to pause when there is no clear evidence that pricing power is abating
Will Monday’s IP print – in which industrial production growth plunged to three per cent – be the straw that broke the camel’s back? Ever since global uncertainty began to rise in early August, there has been a rising chorus arguing for the Reserve Bank of India (RBI) to pause. But asking for a pause seems conservative in the current environment. The rates market are actually pricing in three rate cuts (or a massive easing of liquidity) over the next year. This for a country in which headline inflation is running at 10 per cent, core inflation is twice its historical average, authorities have institutionalised a wage-price spiral in the rural economy, and household inflation expectations have climbed to 13 per cent!
There seem to be three arguments underpinning the case for a pause. The first is that global demand has softened materially. True, growth forecasts for the US and Eurozone have been substantially reduced. From the Indian monetary policy standpoint, however, what matters is the impact of global events on global commodity prices and India’s exports.
Guess what? Global commodity prices have hardly reacted at all! The CRY index of commodity prices is currently only two per cent lower than its level before global stress got exacerbated, global food prices have hardly moved, and Brent is back up at $112! So where is the price relief? Quite the opposite, non-food primary articles within India’s WPI basket actually moved up almost three per cent month-on-month in August and input prices within the manufacturing PMI have surged again. All of this is likely to put more pressure on output prices in the coming weeks.
If anything, events in developed market could lead to further liquidity easing in the months to come. This runs the risk of triggering another bout of global commodity price increases and would necessitate RBI to do more monetary tightening. Not less.
On the export front, undoubtedly India’s sizzling export growth is unlikely to sustain (as evidenced by a sharp decline in August). But 70 per cent of India’s exports go to markets outside the US and Euro area where growth is more buoyant. So while exports may moderate, they are unlikely to collapse.
The second argument is domestic: RBI has done enough and growth has begun to slow precipitously. The problem with this argument is that it is not enough for growth to slow. Instead, growth has to slow enough to significantly dent pricing power. And, there is no clear or sustained evidence that this is the case. Consistent with anecdotal evidence, last month’s inflation print showed that 10 of the 13 sub-categories within manufacturing showed price increases, suggesting that pricing power still exists across the board. Of course, monetary policy has to be forward looking. But it is irresponsible for a central bank to pause unless there is clear evidence that pricing power is fast abating.
Yes, growth is slowing but not collapsing. Rapid wage growth is acting as a key support for consumption and rural consumption should get a big boost from a normal monsoon, indexation of NREGA wages and increases in MSPs. As for Monday’s IP print, the headline is misleading. Volatile capital goods production (which accounts for less than nine per cent of the basket) was primarily responsible for the plunge. Remove capital goods and IP growth is at a four month-high.
And for those who say rates are choking investment, here’s some food for thought: real interest rates were significantly below their averages in the mid-2000s when investment surged. So funding costs are clearly not the binding constraint yet.
The third argument is India should pause because others have. Brazil cut rates explicitly. Indonesia and Philippines eased implicitly and Malaysia paused. But not only are some of these countries far more driven by the global cycle than India, these are not countries in which headline inflation has hovered around 10 per cent for the last 20 months.
Indian policy-makers, in fact, need to be commended for their mid-course correction. They have realised that a policy-induced slowing of growth is critical to reversing inflationary pressures and restoring macroeconomic stability. Delhi has reiterated its resolve to stick to its budget target and keep fiscal policy tight. Now, RBI must keep up its end of the bargain by raising rates and not abandoning its resolve before the job is done.