Repo Rate Cut 25 Bps; MPC’s Diagnosis And Dosage Prescribed Do Not Match

The most interesting part of the Reserve Bank of India’s decision to cut the repo rate by 25 basis points (0.25 per cent) to 6 per cent is how the Monetary Policy Committee (MPC) voted, not the decision itself.

The press note issued after the policy statement today (2 August) said that four members – Chetan Ghate, Pami Dua, Deputy Governor Viral Acharya and Governor Urjit Patel were in favour of cutting rates by 0.25 per cent - while Ravindra Dholakia wanted the repo rate cut by 0.5 per cent. The lone naysayer was Michael Debabrata Patra, who wanted status quo.

The outliers in the MPC vote were thus one from within the RBI (Patra, who wanted no change), and one of the nominees appointed by the finance ministry, Ravindra Dholakia (who wanted a sharper cut).

The good thing about this decision is that it shows that even in the RBI there is scope for dissent with the boss; the bad thing is that the weight of opinion in the RBI, and, by extension, the MPC, is still in favour of too much caution when the economic signals warrant a sharper cut in rates.

The caution cannot be explained easily, given the MPC’s own assessment that “some of the upside risks to inflation have either reduced or not materialised; (i) the baseline path of headline inflation, excluding the HRA impact, has fallen below the projection made in June to a little above 4 per cent by Q4; (ii) inflation, excluding food and fuel, has fallen significantly over the past three months; and, (iii) the rollout of the GST has been smooth and the monsoon normal.”

Further, its opinion on the state of the economy clearly indicated the need for a further easing. The statement said that “there is an urgent need to reinvigorate private investment, remove infrastructure bottlenecks and provide a major thrust to the Pradhan Mantri Awas Yojana for housing needs of all. This hinges on speedier clearance of projects by the states. On their part, the government and the RBI are working in close coordination to resolve large stressed corporate borrowers and recapitalise public sector banks within the fiscal deficit target. These efforts should help restart credit flows to the productive sectors as demand revives.”

If the economy needs a pick-me-up from everybody, and banks needed a booster shot to bottomlines, why did the RBI think it could offer just a teaspoonful of tonic, which the market had anyway discounted, and not go for stronger remedies? The sharp fall in bank shares after the policy shows that more was expected.

While it is no one’s case the inflation will never go up in the coming months if demand picks up and supply constraints emerge, the statement clearly suggests that the RBI still thinks inflation lurks in the shadows. It noted that “the trajectory of inflation in the baseline projection is expected to rise from current lows, (and so) the MPC decided to keep the policy stance neutral and to watch incoming data.”

It can keep looking at data till the cows come home, and at some point it will surely be right. But it can watch some more and see inflation coming down too, if the monsoon produces another bounty and GDP slows in the current quarter as the implementation of the goods and services tax (GST) slows down investment, corporate profits and revenue collections in the initial months.

The Nikkei Purchasing Managers’ Index for manufacturing hit an eight-year low of 47.9 in July, which means manufacturing contracted during the month. Core sector growth was flat at 0.4 per cent in the previous month (June), and could well remain weak (if not turn negative) in July. Eight core sector industries constitute over 40 per cent of the Index of Industrial Production (IIP), and the June index numbers will surely confirm the poor outlook.

The RBI admitted as much. “Business sentiment polled in the manufacturing sector reflects expectations of moderation of activity in Q2 of 2017-18 from the preceding quarter. Moreover, high levels of stress in twin balance sheets – banks and corporations – are likely to deter new investment. With the real estate sector coming under the regulatory umbrella, new project launches may involve extended gestations and, along with the anticipated consolidation in the sector, may restrain growth, with spillovers to construction and ancillary activities. Also, given the limits on raising market borrowings and taxes by states, farm loan waivers are likely to compel a cutback on capital expenditure, with adverse implications for the already damped capex cycle.”

If this is its analysis, why the slowly, slowly approach to cutting rates? The doctor’s prognosis does not square with the final prescription Dr Patel has filled out.

It is difficult to escape the conclusion that the MPC is on a different planet, far removed from the real world of slowdowns and growth pangs.