Economic Survey 2018: In a veiled criticism of the central bank, the Economic Survey on Monday said India’s monetary conditions decoupled from the rest of the world since the middle of 2016, contributing to a slowdown of the domestic economy when the global economy embarked on a synchronous recovery. The country’s real policy interest rates were following the global trend downwards until the middle of 2016. Since then, the downward drift has continued in most other countries, with rates falling on an average by 1 percentage point between July and December 2016 in the US. But in India, the average real interest rates increased by about 2.5 percentage points during the same period, said the Survey. Apart from the tight monetary policy, impact of demonetisation, GST roll-out, twin balance sheet problems (high stressed assets of banks and over-leveraged companies) and rising oil prices in recent quarters also affected growth prospects, it said. This monetary tightening contributed to the divergence in global and Indian economic activity in two ways. “First, it depressed consumption and investment compared to that in other countries. Second, it attracted capital inflows, especially into debt instruments, which caused the rupee to strengthen, dampening both net services exports and the manufacturing trade balance,” it said. Between early-2016 and November 2017, the rupee appreciated by another 9% in real terms against a basket of currencies, hurting export competitiveness. India’s GDP growth rose from 5.5% in 2012-13 to as high as 8% in 2015-16 before slowing to 7.1% in 2016-17. Even in the second part of the Economic Survey of the 2016-17 fiscal, released in August 2017, chief economic adviser Arvind Subramanian had highlighted that the Reserve Bank of India (RBI) had overestimated inflation by more than 100 basis points in six of the 14 quarters until then, with an average error of 180 basis points. The benchmark interest rate of 6% (that, too, after a 25-basis point cut this month) was above the neutral nominal rate by 25-75 basis points, the survey had said.
The RBI trimmed its inflation forecasts for 2017-18 in June last year, after it was increasingly becoming clear that actual price pressure could be lower than the central bank’s initial forecast. It projected headline CPI inflation at 2-3.5% for the first half of 2017-18 and 3.5-4.5% for the second half. In the April policy review, however, the RBI had forecast retail inflation to average 4.5% in the first half of 2017-18 and 5% in the second half. However, the central bank’s revised forecast of the pick-up in retail inflation in the second half of this fiscal has been proven correct.
CPI inflation hit 1.46% in June, the lowest in the current series, before inching up consistently to touch a 17-month high of 5.21% in December. Core CPI inflation moved in the range of 3.9-4.9% this fiscal.
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The minutes of the December 2017 meeting of the monetary policy committee suggest most members saw upside risks to inflation arising from higher oil prices, rising input costs, fiscal slippage and higher inflation expectations.
Pitching for a rate cut, Subramanian has been arguing that even if the pass-through is inadequate, there are gains to financial stability from the rate cuts, as lower cost of funds without a commensurate decline in lending rates will help restore banks’ profitability. Lower rates will also help resolve the twin-balance sheet problem.