Mr Raghuram Rajan’s decision to cut the rate by 50 bps may look like a surprise to many but is a rational and timely decision. More importantly, even the guidance is dovish and one can look forward to at least another 50 bps cut in the next 12 months. It was exactly three years ago, when Mr P Chidambaram spoke about ‘walking alone’. Since then, there has been a lot of media coverage and debate over divergence in the views of government, industry and central bank. Many had opined that a hawkish monetary policy is acting as a brake on the growth acceleration. With Tuesday’s rate cut, the RBI can no longer be blamed for ‘being behind the curve’ or ‘not doing its bit’ to revive investment or growth RBI’s decision to cut the rate by 50 bps is data-driven and not anything to do with government’s persuasion.
Inflation is down sustainably and medium-term outlook for commodity prices is bearish. The credit growth has been very sluggish. There are clear evidences that government is committed to fiscal consolidation and discipline.
Indian currency has been fairly stable despite rate cut and markets have taken news positively. Indian stocks have rallied despite bearish sentiment for emerging markets today.
What we need to delve into is “Will this indeed be the turning point for sentiment and economy? Will it result in acceleration in credit offtake, revival of private investment, faster economic growth and corporate earnings?” The rate cut is not the magic wand or panacea for all the problems or challenges that the economy faces. There is widespread perception that government is on the right track but is very slow.
More often than not, perceptions matter more as there is no certainty on what realty is. This is the opportune time for the government to act. The upbeat sentiment of last year was waning due to disappointment with the pace of progress. It seems that sentiment has turned around once again to be positive. The government’s decisive action on reviving investment — both domestic and foreign will have greater impact in this environment. While there is some progress on stalled projects, the task is long way from being complete. The government has stepped up public investment in infrastructure in sectors like roads, power, railways and defence. But it needs to hasten and do a lot more. As Rajan said in his statement “construction activity is weakening… rising public expenditure on roads, ports and eventually railways could, however, provide some boost to construction going forward”. There is still very little progress on ‘ease of doing business’ and a lot can be done without needing parliamentary consent.
Banking sector’s NPA problem needs a more focussed and prompt action. RBI and the government can work together to solve systemic issues to ensure adequate transmission of rate cuts by the banks. Consumption demand too, has been weak and should receive a boost. It is hoped that gradual recovery in consumption demand, leading to better capacity utilisation and lower interest outgo, would create the right environment for recovery in industrial investment.
Although RBI’s statement points out that there is still significant excess capacity indicating that it may take a while for investment cycle to pick up. I think when we talk about excess capacity as a whole, we miss out on the fact that the average capacity utilisation for nation as a whole would hide the sectoral differences. Investment pick up in some sectors, where there is relatively fuller capacity utilisation or better margins, would be the beginning of revival of upward cycle.
Once the sentiment turns optimistic, it gathers momentum on its own. All investment decisions are based on expectations of profit as you would discover real profits long after actual investments. Therefore, optimistic outlook is so important and often a self-fulfilling prophesy. India can clearly emerge as the fastest growing nation as early as this year or next. This coupled with China’s slowdown and soft crude oil and commodity prices can potentially make India as the most attractive investment destination. The government can get its acts together to make the most of this opportunity. The ball is now firmly in the government’s court.
Source: The Economic Times