While the November manufacturing PMI data, which moderated to 52.3 from 54.4 in October, does point to a slowdown, it doesn’t reflect the kind of severe setback that had been anticipated following the demonetisation of high currency notes on November 8. It is possible the data may not have fully captured the impact on businesses and retail outlets caused by the acute scarcity of cash and that the true levels of disruption will be known only in the coming months. In the meantime, it is evident the economy is stressed and that sales of a host of goods including not just cars, jewellery, white goods, tractors, etc, but also other non-essentials, have slowed sharply. The momentum, both in the industrial and retail sectors, should be regained once there is more cash in the system but there is no denying the stress in the near-term will take a toll on the economy. The risks of growth slipping to sub-7% levels this year is now real though economists believe it should rebound next year.
Which is why there is near certainty that RBI will trim the key repo rate by at least 25 basis points next week. Even without the deleterious effects of the demonetisation, a rate cut would not have been out of place. For one, inflation has been benign—October CPI came in at 4.2%, down from 4.4% in September—and very much within the central bank’s comfort range of 4%±2%. For another, there has been some transmission—30-40 basis points—of past cuts in the repo into lower lending rates, albeit via the MCLR (marginal cost of lending rate); a repo cut could prod banks into lowering rates further.
More important, while the economy did see a pick up in the September quarter—real GDP growth accelerated marginally to 7.35 in Q2FY17 from 7.1% in Q1FY17—the non-agri sector grew at a ten-quarter low. Critically, investments—gross fixed capital formation—contracted for the third straight quarter, by 5.6%. The moderation in the growth in services in Q2FY17 was also disconcerting given there was strong support from a 12.5% increase in the public administration and other services category bumped up by the higher salaries and arrears paid to government employees. As Sonal Varma, economist at Nomura points out, excluding public administration and agriculture, the growth in Gross Value Added (GVA) decelerated sharply to 6.7% in Q2FY17 from 7.6% in Q1FY17. It was consumption which drove growth in Q2FY17 on the back of a slight recovery in rural demand and higher payouts to government employees. Consumption, in fact, accelerated to 8.9% in Q2FY17 from 8.7% in Q1FY17, despite a deceleration in public consumption to 15.2%. The shortage of cash will most certainly crimp consumption for at least six months if not longer. However, there is a chance that lower interest rates could stimulate demand for home loans or car loans even if they don’t persuade companies to step up investments. The slowdown in the economy is bound to result in greenfield, or even brownfield, ventures being pushed back, but lower borrowing costs will give hundreds of smaller companies a breather.