Global uncertainty rises, relook monetary policy
Even if, as some experts have been arguing, too much mustn’t be made of the Chinese stock market crash given how thin the number of investors are, there can be little doubt that, as the Fed tightens liquidity in the US and the dollar strengthens, there will be more outflows from China and more volatility in global markets—and going by the way the Chinese authorities have reacted, the government seems a lot more willing to let the yuan depreciate, more so given how China’s exports are in trouble. Add to this, the obvious weakness of the Chinese economy, and how long it will take to be able to rebalance, more such shocks with each negative piece of news can be expected. Also, prospects for global growth are looking increasingly shaky with each passing day. The IMF, in October, once again lowered its forecasts for 2015 to 3.1% from 3.3% in the July forecast and to 3.6% for 2016 as compared to 3.8% earlier. The World Bank’s forecast, out last week, has cut global growth in 2016 to just 2.9% as compared to 3.3% in June—in which case, it is likely the next IMF forecast could once again lower growth estimates. In any case, February futures for Brent at $33—and Canadian crude is already selling in physical markets at under $20—suggest future global growth may slow down even more. While that may signal less strain on India’s twin deficits, this will slow expenditure in oil-exporting countries from where the bulk of India’s remittances come. Slower global growth also means a vital engine powering India’s GDP will remain out of commission for at least 2016.
What will compound finance minister Arun Jaitley’s problems is the sharp reduction in nominal growth, thanks to the large difference between WPI and CPI inflation. With the CPI high due to structural rigidities with regard to food inflation, the wedge is unlikely to narrow quickly, in which case, FY17 could be a repeat of FY16. Apart from what that means for the fiscal deficit, with real lending rates so high, the chances of investment picking up have been further dashed—they were, in any case, poor thanks to the huge debt overhang over India Inc. That, of course, is why, when RBI Governor Raghuram Rajan first started talking of inflation-targeting and using CPI instead of WPI, this newspaper argued against it. Given the rigid framework that is an inherent part of inflation-targetting, it is not surprising RBI cannot lower rates much—in the absence of that, the heavy lifting is then left to the fiscal deficit and that has its own ramifications. The finance minister would do well to, in his next budget, formally renounce his government’s commitment to inflation-targeting—it has not worked in other parts of the world, and it won’t in India either. A related issue, of transmitting even the limited cuts RBI has made, also needs to be addressed urgently—if small savings rates are going to be kept as high as they are today, banks cannot cut deposit rates and, therefore, cannot pass on repo cuts either.