Take any number you like and it is obvious the economy continues to remain fragile, never mind what the GDP data is saying. Credit growth in Q1FY16 is a mere 9.8% as compared to 13.4% a year ago, IIP continues to hover in the 2-3% range with core sector growth in the 3-4% range. For a sample of 217 companies, excluding banks and financials, net profits in Q1 rose barely 3.6% y-o-y as compared to 10.4% in even the March quarter and this is despite the relief in raw material prices. Indeed, with WPI negative for 8 months now, had RBI not changed its operating metric, ill-advisedly in this newspaper’s opinion, to CPI inflation, repo rates would have been cut very sharply by now. Also, contrary to popular belief, it is not just fuel prices that are driving the WPI into negative territory, even manufacturing WPI has been negative for the past 4 months, making it clear there is simply no demand in the market—volumes at cement-maker ACC fell 2% y-o-y in the latest quarter while realisations fell by 1% with margins tumbling to a decadal low.
But, inflation hawks will argue, there is no scope for a rate-cut right now. With June CPI edging up to 5.4% from 5% in May, inflation will probably be around the 6% target for the year—in which case, given RBI’s desired real-interest corridor of 1.5-2%, there isn’t any room to cut interest rates further with the current repo rate being 7.25%. This is, however, a mechanical way of looking at inflation/rates since, right now, it is vital to spur demand—why have an RBI if the rate-setting exercise is going to be so mechanical? Also, with Europe on the verge of deflation (inflation is at 0.2%), China looking very weak (1.4% inflation) and US inflation at below 2% for the third year running, it is likely that global deflationary pressures are going to come to bear on Indian inflation—in which case, FY16 could end with a sub-6% CPI inflation. And while RBI should not be heavily focussed on food inflation—since it can do little to control it through interest rates—with the monsoon position looking better as compared to the time when the Met had forecast a 12% shortfall, food prices could also stay under control.
The impact of not cutting rates, in such a situation, will worsen the current slump. With negative WPI, the effective interest rates for corporate India are in the 12-13% range—though there is a lot of excess capacity right now in most sectors, who is going to invest at such high rates, more so when the growth prospects look so weak? If RBI cuts rates on Tuesday, and along with this, the government is able to convince banks to pass this on to borrowers, this will help in two ways. For one, it will lower the interest burden for existing borrowers. More important, it will stimulate some increase in consumer spending. It is true that consumer demand will be more driven by prospects of more jobs and salary hikes rather than just lower interest rates, so any stimulation is likely to be a weak one. But the converse is that if rate-cuts are not going to spur demand, they cannot add to inflationary pressure either. It doesn’t seem that difficult a call for the central bank.