A signal failure

Reserve Bank of India met today and cut the repo rate to 7.25% from 7.5%. It was widely expected. It did not leave the door open for another rate cut. In fact, the statement noted that it had front-loaded a rate cut today, thus ruling out further cuts this year. It has cut rates by 75 basis points this year. For some reason, the economy does not appear like one that is growing at 7.3% to 7.6%. The statistical growth rate reported recently has still left many of us with more questions than answers on the true growth rate. RBI has reduced the forecast for Gross Value Added to 7.6% from 7.8% (its preferred measure of output growth than GDP growth estimate) for the year 2015-16. It has slightly increased its inflation forecast for January 2016 to 6.0% from 5.8%. Elsewhere, in its monetary policy statement, the Indian central bank has more to say on indicators of growth slowdown than on inflation acceleration. So, that possibly argued for a front-loaded 50-basis point rate cut.

From a short-term perspective, a more aggressive rate cut of 50 basis points would have carried a greater signalling effect. After all, the Indian Central Bank acknowledges that signs of accelerating food inflation are missing from the unseasonal rains of the Spring months. So, one wonders if aggregate demand were not weaker than what is indicated by statistical growth estimates. Should that not inform the central bank decision more than the fear of potential inflation risks carried by a potentially weak monsoon?

Of course, from a medium-to-long-term perspective, India’s real interest rate is not that high (one is not using wholesale price inflation here, of course), especially if the economy were indeed growing at 7.5%. Further, it is not at all clear if interest rates are the ones holding India back.  Clearly, if export growth has dropped both in value and volume terms for four to five consecutive months, there is a problem with India’s competitiveness. After all, according to the BIS measure of Real Effective Exchange Rate, the Indian rupee is still 10% more competitive than it was in 2010. As long as India remains a stagflation-prone economy due to poor worker attitudes towards productivity and corporate promoters’ attitudes towards the broader economy, the central bank in India will invariably be biased towards more restrictive and not easier policy stance.

So, I am not overly critical of RBI for not having cut rates by 50 basis points. In his shoes, I would have dropped rates by 50 basis points and clearly moved to a neutral stance, pointing out that rates could move either way, depending on the evolution of inflation and growth data in the coming months. That is what I had indicated in my MINT column before the April monetary policy meeting of RBI and in my column today as well.

Now, the Indian stock market has fallen predictably, not only because RBI cut rates ‘only’ by 25 basis points but also indicated that doors to future rate cuts are now closed. The onus of growth is on monsoon, on the government and luck. The monsoon has failed to arrive early and it is now reported that it would bring in lesser rains than estimated earlier. Notwithstanding statistical data that points to 7+% growth rate, sentiment on the ground remains fragile and uncertain and could turn on a dime. That is what has happened after the RBI meeting. That is why it was important for the RBI to signal that it was aware of growth and sentiment risks. It had left it to the government. Read the last paragraph of the monetary policy statement.

Hence, notwithstanding the fact that Indian stock markets remain investors’ favourite among BRIC countries (and correctly so), stocks have fallen hard. But, medium to long-term investors should and would be pleased. They can buy the India story at lower prices today. The India story remains intact. For evidence, look at this story. It may not be widely flagged (and perhaps, just as well) but it is significant. That shows that the government has a map and a destination for its policies.

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