Key weakness lies in investment, says outgoing RBI governor
Reserve Bank of India (RBI) governor Raghuram Rajan on Monday in the central bank’s FY16 annual report that although the economy is showing signs of picking up, it is still below levels that the country is capable of.
The key weakness is in investment, with private corporate investment being subdued because of low capacity utilisation, and public investment slow in rolling out in some sectors, he said.
“Inflation projections are still at the upper limits of RBI’s inflation objective,” Rajan said, adding that with the RBI needing to balance savers’ desire for positive real interest rates with corporate investors’ and retail borrowers’ need for low nominal borrowing rates, the room to cut policy rates can emerge only if inflation is projected to fall further.
He explained that the willingness of banks to cut lending rates is muted and not only does weak corporate investment reduce the volume of new profitable loans, their stressed assets have tightened capital positions, which may prevent them from lending freely. “Certainly, the reluctance to lend to industry and small businesses is more visible among the more stressed public sector banks compared to the private sector banks,” Rajan said.
The governor said both the government and RBI were engaged in the last few years in restoring macroeconomic stability to the economy and while policy actions have had positive effects, these are a number of areas which should be considered “work in progress”.
However, he said expectations of a good monsoon, coupled with more money in the hands of government servants (as a result of the implementation of the 7th Pay Commission recommendations), should boost the consumer demand. “With final demand picking up, capacity utilisation is likely to increase, and so will investment. A virtuous cycle of growth is possible,
reinforced by anticipation of the coming benefits from reforms such as the recently-passed Goods and Services Tax legislation in Parliament,” he added.
Rajan reiterated that short-term macroeconomic priorities of the central bank continue to be to focus on reducing inflation toward the target of 4% – thus far the RBI has followed a gentle glide path, aiming at 5% by March 2017 after it came below 6% in January 2016. He stressed the need for more participation in the financial markets to increase their size, depth, and liquidity.
According to the governor, participation is best enhanced not through subventions and subsidies but by creating supporting frameworks and new institutions that improve transparency, contract enforcement, and protections for market participants against abusive practices.