With GDP growth sharply decelerating to 5.3% in the last quarter of 2011-12, RBI Governor D Subbbarao?s job becomes quite easy during the mid-June quarterly review of monetary policy. The bias of the central bank will more pronouncedly shift in favour of propping growth, especially with the latest data set showing a negative growth in manufacturing during January-March 2012.
The business community has been gripped by a sort of investment pessimism for a while now. To be fair, RBI had a good idea of this phenomenon and it had indeed clearly pointed out in its early April credit policy statement that the pricing power of the manufacturing sector was declining. In fact, RBI found the courage to cut the key repo rate by 50 basis points precisely on the assumption that, at an aggregate macro level, the declining pricing power of the manufacturing sector would temper the potential inflationary impact of future oil price increases. This assessment by RBI seems to have proved right, even though one may argue that the central bank has been late in moving on with the interest rate cuts. There is now a strong case for making a sharp rate cut, perhaps even by 75 basis points over the next two quarters.
After the 50 basis points cut in April, the RBI Governor had also indicated that the scope for further cuts may be limited. While arguing that the pricing power of the manufacturing sector was getting weaker, he seemed a bit tentative about how oil prices would behave and what impact they would end up having on domestic inflation. He also had worries about the Centre?s fiscal correction, which was largely predicated on the oil price hikes promised in the Budget. Thirdly, there was a big worry about the management of the sharply widening current account deficit, which had reached close to 4% in end March 2012. The good news is that the wall of worry is looking very easy to climb on all these fronts, with oil prices?and indeed most global commodity prices?having come down sharply over the past month, as the global economy looks much weaker than it seemed earlier this year.
Many global commodity prices have slumped 15-20% since the Union Budget was presented in March. The Budget had assumed an average oil price of $115 for determining oil subsidies. Neither the finance ministry nor RBI had anticipated that oil prices would come down to below $100 a barrel, from $125 at the time of the presentation of the Budget. The good news is that incremental demand for oil and other minerals is decelerating sharply in China, where growth is moderating.
The falling commodity prices will have a major moderating effect on core inflation and the central bank may be well on its way to achieving the inflation target of 6.5% set for 2012-13. At the rate at which commodity prices are falling, core inflation should easily go back to below 5%. With monsoons having arrived on time and the government godowns bursting with over 70 million tonnes of foodgrains (far more than the government?s storage capacity), the time is right to move ahead with distribution logistics on a war footing, thus tempering expectations of a rise in food inflation also. The Centre must focus all its attention on distribution and supply chain logistics for the abundantly available food. This does not require support from coalition partners as it is a purely administrative matter.
If the UPA can manage expectations on food prices, then the economy could easily come back to the median growth path after some meaningful cuts in interest rates. The conditions are very ripe now for the monetary and fiscal authorities to complement each other with appropriate actions. If average oil prices stay around $100 a barrel, as many are now inclined to believe, the fiscal and current account problems would also tend to get mitigated.
It is safe to assume that if oil prices remain around $100 a barrel, and the declining gold import trend continues, then the current account deficit for 2012-13 will revert to the mean figure of 2.5-3% of GDP. This would mean the economy will need a net capital inflow of just about $55 billion to meet the current account gap. This is easily manageable. Again, this perception will stabilise the rupee, which has been getting hammered badly of late.
Already, the declining prices of oil and other commodities are having a positive impact on the current account. The current account deficit, which was 4.8% of GDP in the third quarter of 2011-12, has moderated considerably in the fourth quarter. The first quarter of 2012-13 would be even better as the impact of falling commodity prices gets factored in even more.
Seeing some of these trends, the speculators in the currency market have also developed doubts about whether the rupee will weaken further in the months ahead. If some of the positive trends as outlined above were to come to pass, then the rupee may even come back to a range of R50-52 to a dollar in the near term.
The Centre must make the most of of these fortuitous events that are coming together to make the economy tick again. A few decisions, signalling that the government is back to work, would be good enough in these circumstances. Is that asking for too much?
mk.venu@expressindia.com