Rajan must have freedom on rate cut
By S. Sethuraman
The steep fall in international oil prices is the biggest positive on the economic horizon, however uncertain its durability, to become a windfall for the Modi Government to postulate a turnaround in fiscal balancing, controlled inflation, comforting external position and growth recovery. No doubt, Finance Minister Mr Arun Jaitley has begun to talk in glowing terms of economy heading for 8 per cent growth on the back of his yet-to-be tested reform agenda.
But with all its overwhelming strength and stability and the all-round expectations of the Modi Government for a strong rebound of the economy, the first six months saw little of substance in macro-economic management, whatever the structural factors it may be struggling with in coal for electricity, or in toning up of infrastructure and services.
In the first half of current fiscal year overall, GDP is estimated to have grown by 5.5 per cent, after a relatively poorer second quarter (July-September) performance at 5.3 per cent as against the 5.7 per cent in the first April-June quarter, for which Government promptly took unjustifiable credit. But manufacturing again stagnated in the second quarter and, beyond sentiment, the pro-reform Government has so far failed to ignite investment. It does not seem that the third quarter holds any promise either, judging by trends in October-November, barring a decline in inflation from the earlier highs, due largely to base effect (which also does not rule out a reversal of the downtrend in the coming months).
Meanwhile, the oil bonanza made it bold for the NDA Government to deregulate diesel prices and proclaim the launch of subsidy reform. But while helping to limit subsidy outgo, the budget had already run into a huge fiscal deficit of 82.6 per cent in the first half of fiscal year, the non-plan expenditure outrunning receipts by a large margin. Government has renewed its “austerity” drive- euphemism for cuts in plan allocations, mainly – while all assumed non-tax revenues to narrow fiscal gap, like disinvestment and spectrum auctions, remain backloaded into the fag end of fiscal year. There is as yet no clarity on the fiscal front, whether the budgeted target of 4.1 per cent of GDP can be taken for granted.
With so much to do on fiscal front, letting inflationary expectations prevail, and only citing the drop in CPI (not as much in prices of food and other basic products of consumption) in the context of fall in global commodity prices, the Finance Minister thinks it is time for RBI to make a rate cut. Dr Raghuram Rajan has thus once again come under pressure but he may have a larger compelling picture of risks, domestic and global, to defer a repo cut till the fourth quarter, which would give time for the risks to work themselves out.
There are imminent risks of spillovers from global developments like deflation in euro-zone, which would warrant QE by the European Central Bank, while the slowdown in Japan and China also impact on demand and growth here. But the Finance Minister apparently does not take these risks on the global front seriously with his belief that a rate cut would become the best solvent in an otherwise bad plight that the Government finds itself in.
He may also be assuming that lower oil prices would stay so for quite a long time. Welcome in several aspects that a durable price decline would be in regard to macro-economic fundamentals and boosting growth of the economy, lower oil prices would also have a series of negative effects: it would affect the petro-dollar flows into India, mainly remittances from NRIs, and also our petroleum product export earnings. Further, it could involve re-pricing natural gas and other energy products and create some uncertainty in investments in oil-related sectors. A sudden turn in the geo-political factors is likely to trigger an oil bounce-back as lower prices spur consumption demand globally and supply constraints could also emerge, in spite of what it looks today as one of global oversupply.
Apart from global uncertainty, Dr Rajan would also be guided by the disinflationary path that RBI has worked out. He has in the past not ruled out policy easing as and when it becomes clear that disinflation, adjusting for base effects, is accelerating faster than currently anticipated. While the repo rate has been held at 8 per cent since January last to control inflation, RBI Governor had reduced the SLR. This was to give the banking system more liquidity, but credit growth has lagged behind because of lack of demand and an investment standstill. By mid-November bank credit growth was a mere 4.3 per cent in the first seven and a half months of current fiscal as against 7.1 per cent in the corresponding period of fiscal 2014.
This has more to do with the policy environment than the policy lending rate, and if and when there is a confluence of positive factors, Governor Rajan would come up with a rate appropriate to the needs of the situation. If, as assumed, growth recovery becomes stronger with an investment pick-up and global environment meanwhile also turns less turbulent, while CPI continues to remain soft, Dr. Rajan woud have scope to move the policy toward growth. Finding that all the noise made about growth and reforms had not evoked commensurate response from investors, the Finance Minister is now talking more forcefully of his determination to push his reform agenda, overcoming any political “obstructions”, given the Government’s commanding majority.
His immediate priority is to facilitate land acquisition for projects, move to encourage manufacturing, and facilitate private investments in coal and mining of other minerals. Mr Jaitley hopes to get legislation through on coal and GST in the current session of Parliament.
But he must first get over the gridlock on the insurance bill. Land acquisition could become a tougher proposition and may have to be deferred to the budget session. It is therefore he has indirectly talked of a joint sitting of the Houses to push difficult reforms with the requisite majority at Government’s command.
Mr Jaitley has also indicated that he would make the tax regime more friendly for investors, foreign and domestic, and possibly do away with irksome provisions such as retrospective taxation. Government has significantly decided not to go in appeal against High Court judgements in the tax cases of Vodafone and Shell.
Government is also working out, according to him, on plans for a new “appropriate” tax regime as well as on ensuring better infrastructure and competitive interest rates in order to make a success of the “Make in India” programme for revival of manufacturing and creating jobs, on which Prime Minister Narendra Modi has staked his prestige. (IPA Service)