The Monetary Policy Committee’s stance is in line with our expectation. To be sure, there are concerns with GDP growth sliding down to a thirteen-quarter low of 5.7% in the first quarter of fiscal 2018. But a large part of the slowdown is expected to be transitory, led by waning impact of demonetisation and initial hiccups because of the implementation of GST.
Though this does bring down our full-year GDP growth estimate to 7% (from 7.4% earlier, and also below the fiscal 2017 estimate of 7.1%), the economy will grind up over the next few quarters as the impact of demonetisation and destocking due to GST implementation wears off. Preliminary signs of bottoming out in some sectors are visible — auto sales have started picking up in July and August led by passenger and commercial vehicles, while core infrastructure sector data shows that on-year production growth so far in the second quarter is higher than in the previous quarter.
Meanwhile, although inflation remains within the 4% band, its steady rise has led the MPC to flag concerns. Waning of low-base effect, some bump up in oil prices, and the possible impact of GST have led to a rapid rise in the consumer price index (CPI)-based inflation. In August, CPI inflation jumped to 3.4% from 2.4% in July.
More importantly, despite the dent in demand due to recent disruptions, core inflation (which excluded food, fuel, light, petrol and diesel) has stayed quite sticky. Core inflation fell just 120 bps from its peak in June 2016 to 3.9% in June 2017, whereas overall inflation fell 460 bps during that period. Core inflation has now climbed up to 4.4%.
Going ahead, if the risks to growth rise, and inflation undershoots the MPC’s forecast, then there is a possibility of a rate cut. The second-quarter GDP data will be a key deciding factor. If growth sulks down further, it can potentially bring down core inflation, too. A dip in core can provide a faster downside to overall inflation. Meanwhile, reasonably healthy food production aided by good monsoon will keep food inflation low, too.
A rate cut at this juncture will only mildly support private consumption in our view. Private investment revival hinges on many other factors which are yet not favourable. Capacity overhang and high leverage that persist in many sectors will hold back any meaningful revival of private investment this fiscal. And with government’s ability to spend constrained by the fiscal math, overall investments will remain subdued this year as well. Private consumption will, therefore, be the key driver of growth.
The role of private consumption is important because unless huge capacities with manufacturing firms are utilised, appetite to invest will not come by. Currently, some levers to push up consumption growth in the economy are active. These include a near-normal monsoon, benign inflation, lower interest rates facilitated by improved transmission post demonetisation, the Seventh Pay Commission revision-led increases in salaries and pensions, and the retail focus of banks and non-banks. However, the dent to demand due to demonetisation has prolonged because of the uncertainty following the implementation of GST.
(The writer is chief economist, Crisil)