Bi-monthly monetary policy reviews do not seem to serve much purpose. The growth projections this time are optimistic
The policy was in line with expectations. No changes in interest rates or in cash reserve ratio. Inflation forecast for the second half of 2017-18 has been slightly raised to 4.3-4.7 per cent from the forecast of 4.2-4.6 per cent made in the October policy. The forecast for Gross Value Added (GVA) at 6.7 per cent for the full year is unchanged from the forecast made in October 2017.
With the primary focus of the monetary policy on the CPI target of 4 per cent, the discussion around monetary policy is essentially around the inflation outlook. Even when CPI inflation was consistently trending lower — from 4.5 per cent in April 2016 to its all time low of 1.54 per cent in June 2017 — the Reserve Bank of India kept its inflation forecast unchanged at around 5 per cent till June 2017, when it reduced to below 4 per cent for the first time. Despite inflation having fallen lower by 200 bps in 2016-17 and the first half of 2017-18, the RBI reduced the policy rate by only 50 bps in the period since April 2016. In retrospect, this seems to have been a prudent decision, as inflation has started inching up and so have inflationary expectations.
The question this raises is whether having a monetary policy review and forecasts at such frequent intervals, with all the hype surrounding it, is good for the economy. It is not very clear to what extent inflation is responsive to interest rates in India. It rather seems that the Monetary Policy Committee’s task is to ensure that the policy rate is in line with inflation rates over a half year/full year, rather than on a bi-monthly basis. Food prices, oil prices and the fiscal deficit seem to have greater impact on inflation outcomes in India. In reality, it seems that the role of the monetary policy is to anchor expectations and avoid excess volatility.
The MPC objective is to achieve the medium-term target for consumer price index (CPI) inflation of four per cent within a band of +/- 2 per cent, while supporting growth.
If it is accepted that the policy rate does not have that much influence on inflation in India, how much influence does the policy rate have on growth? If the outlook for growth happens to be lower than the potential output, would the MPC be failing in its responsibility if the forecast for growth is not achieved, while remaining within the inflation target?
The RBI growth outlook for the year at 6.7 per cent which, as was revealed in the press meet, implies a growth rate of 7 per cent in Q3 and 7.8 per cent in Q4.
The growth graph
The monetary policy statement attributes the GVA acceleration in Q2 to the manufacturing sector on improved demand and restocking post GST. In contrast, growth in agriculture and allied activities slackened, reflecting the lower than expected kharif harvest. Activity in the services sector decelerated, mainly on account of slowdown in financial, insurance, real estate and professional services, and in public administration, defence and other services (PADO) following the large front-loading of government expenditure in Q1. Despite some improvement, construction sector growth remained tepid due to transitory effects of the RERA and GST implementation. Growth in the trade, hotels, transport and communications sub-group remained resilient, in spite of some slowdown in growth in Q2 as compared with the previous quarter. On the expenditure side, the growth of gross fixed capital formation improved for the second successive quarter. However, growth in private final consumption expenditure — the mainstay of aggregate demand — slowed to an eight-quarter low in Q2. The data provided for Q3, as also taking into account that there will be no restocking effect, convey a mixed bag and do not provide much confidence that the growth rate could be much higher than in Q2.
Turning to GVA projections for Q4, the statement says that the recent increase in oil prices may have a negative impact on margins of firms and GVA growth. Shortfalls in kharif production and rabi sowing pose downside risks to the outlook for agriculture. On the positive side, there has been some pick up in credit growth in recent months. The RBI however expects an improvement in demand, financial conditions and the overall business situation in Q4. It needs to be noted however the year-on-year credit growth till November 10, 2017, was 8.6 per cent compared to 7.5 per cent in the previous year. Moreover, the sectoral deployment of credit till October 2017 shows the bulk of credit growth in credit cards and personal loans (other than asset financing) and to a small extent in housing. There will also be the impact of lower government expenditure in Q4 as in Q3 and Q2 unless of course there is fiscal slippage.
Not really clear
The outlook for growth seems to be based on the success of new issues in capital market, ease of doing business ranking, and the initiatives for dealing with the twin balance sheet problem, namely, distressed companies through the Insolvency and Bankruptcy Code and distressed banks through recapitalisation of public sector banks. These are all positive indicators and initiatives, but they cannot be expected to deliver 7.8 per cent growth in just three months.
So the mystery remains: What underlies the growth outlook of 6.7 per cent for 2017-18?
The writer is a former deputy governor of the RBI. Via The Billion Press