Given how often, and by how much, RBI has got its inflation forecasts wrong—recall CEA Arvind Subramanian’s statement of projections that were “large and systematically one-sided in over-stating inflation”—and how low inflation levels have been, it is not surprising the central bank has cut repo rates by 25bps. And to ensure there is as much transmission as possible, RBI has set up a study group to improve monetary transmission including ‘exploring linking of the bank lending rates directly to market determined benchmarks’. While most analysts seem of the view that Wednesday’s monetary policy statement leaves no room for another cut, a lot depends on how inflation plays out. If, as Subramanian believes, India is witnessing a paradigm shift towards lower inflation, there could well be another cut—the monetary policy statement also alludes to ‘moderating forces at work’.
A rate cut, should it be transmitted—and SBI’s moves in cutting deposit rates on Tuesday suggests this could be the case—will certainly be positive, by how much needs to be seen. Certainly, India Inc will be less stressed if interest rates on its borrowing are reduced, and demand for both durables and housing should improve—real interest rates are at a 15-year high right now. It must, of course, be kept in mind that while interest rates are important, there is just that much they can do on their own. In the case of housing loans, for instance, despite interest rates being cut, credit growth has been slipping for the last four months as, post-demonetisation and the introduction of RERA, buyers are waiting for some more correction in prices before they purchase apartments/houses. Investments by corporates should rise with the cost of money falling, but with 25% levels of spare capacity and with little demand visibility—excluding Reliance and Vedanta, a sample of 259 early-birds saw Q1 revenues rising a mere 3.6% y-o-y—this is unlikely to happen in a hurry. July’s PMI was unusually low—47.9—due to pre-GST-destocking, but momentum was slowing even before that; 50.9 in June, 51.6 in May and 52.5 in April.
In a poor investment climate, it is incumbent upon the government to do as much as it can to remove policy bottlenecks and address specific industry pain-points. Fixing retrospective tax laws, for instance, is something that will affect overall business sentiment but what is far more important is fixing regressive labour laws—far from addressing this, the Cabinet has cleared a law that, if passed by Parliament and the states then agree to it, can cause a sharp upward movement in wages. And while a special package was announced to take care of some of these issues in the case of apparel—this was to be extended to other sectors over a period of time—bureaucratic delays have dogged the project. If raising natural gas prices nearer to market levels—albeit after two years—improved investor sentiment in the petroleum industry, the telecom industry is reeling under the impact of both RJio and government policy that borders on being extortionist; a government committee is looking into the matter and its report is expected soon. The central bank has been slow to cut rates, but that cannot be an excuse for the government not to do its bit.