If FY15 GDP is equally inexplicable, could affect rate cuts
Few expected RBI Governor Raghuram Rajan to cut rates in Tuesday’s policy given no new data has emerged since the time he last cut rates on January 15. To be sure, core sector growth has slowed and manufacturing PMI is at a 3-month low, but there has been no IIP data, nor has there been any inflation numbers either. What has complicated things tremendously, though, has been the latest rebasing of GDP—from FY05 to FY12—which has caused the FY14 growth number to jump dramatically from 4.7% under the earlier series to an exceptionally healthy 6.9%. It is not certain whether this will be reflected in the advance estimates for FY15 which are due next week Monday, but it cannot be ruled out. Should that happen, RBI will have to recalibrate its model, which is why Rajan said RBI would be carefully looking at what the new GDP numbers will throw up next week. Rebasing of the consumer price index (CPI), also expected next week, is not expected to change the CPI too much since what is being done is to change the weights—weights for food and fuel are being reduced by 4.4 percentage points while those of other items are being raised—but given the GDP experience, it may be wise to wait for the actual data to come out.
In yesterday’s policy statement, as well as during the press conference, Governor Rajan was somewhat sceptical of the quality of the latest GDP data—the policy statement reads “growth expectations should be tempered as lead indicators such as tractor and motorcycle sales and slowing rural wage growth all point to subdued rural demand”. Indeed, chief economic advisor Arvind Subramanian was even more scathing in an interview to the Business Standard where he said he was puzzled by the new GDP numbers that suggested the economy didn’t do as badly as thought earlier in FY14. The year FY14, he said, was a crisis year in that capital flowed out, interest rates were tightened and government spending badly squeezed. And yet, growth rallied so well. Indeed, as Subramanian asks, how does the new GDP data reconcile the fall in imports of goods with the expanding GDP?
In which case, RBI has a peculiar problem on its hand. Its current policy stance is largely dictated by what happens on inflation as well as on growth. At Tuesday’s press conference, the Governor reiterated his stance of the real policy rate being in the 1.5% range. Which means that, given Citibank’s 5.5% expected CPI for FY16, another 75 bps of rate cuts can be expected during the rest of the year. The problem, however, will be with the IIP. The revised GDP presented on Monday projects a very different industrial growth than the IIP data does—and the revised IIP series with the FY12 base is not expected till March 2016. In which case, it is not clear what RBI is going to use as its growth compass for the next 15 months. While there are substitutes in the form of corporate data, credit growth and imports/exports, it will be an odd situation in which the IIP data could be telling one story while the quarterly GDP data will tell another.