MPC members flag weak investment growth and its impact on economy

Even as the Monetary Policy Committee (MPC) voted 4-2 vote in favour of a 25-basis-point cut in the repo rate, majority of the members flagged their concern regarding weak investment growth and its impact on economic growth, according to the minutes of the meeting released by the Reserve Bank of India on Wednesday.

The MPC has six members — Chetan Ghate (Professor, Indian Statistical Institute), Pami Dua (Director, Delhi School of Economics), Ravindra Dholakia (Professor, Indian Institute of Management, Ahmedabad), Michael Debabrata Patra (Executive Director, RBI), Viral Acharya (Deputy Governor, RBI), and Urjit Patel (Governor, RBI).

Ghate observed that while re-monetisation, front-loaded government expenditure and a good monsoon will sustain the positive momentum on growth, his biggest concern now is the slowing rate of capital accumulation.

“Indebted manufacturing companies continue to de-leverage, and the envisaged capex continues to decline. A prolonged period of weak investment growth will impact potential growth,” he said.

He felt that both farm loan waivers and proximity to the 2019 election year suggest that fiscal impulses could contribute to inflationary pressures. These need to be carefully watched.

Dua underscored the fact that the twin problems of weak capex cycle and debt overhang have constrained the private sector from undertaking new investment. Infrastructure bottlenecks are also a major constraint, while the government’s plan for housing to all may provide an impetus to growth.

Dholakia said the industrial outlook survey and household expectations survey by the RBI do not paint a rosy picture of the economy. The manufacturing purchasing managers’ index (PMI) has declined to a contraction zone in July 2017.

The IIM Professor elaborated that “Rupee has continually appreciated and exports are not doing well. Investment demand is not picking up…expanding negative output gap in India cannot be wished away, but needs immediate aggressive policy action to correct it. Persistence of negative output gap imposes severe social costs on the economy that is largely borne by the poor and the unemployed.”

While batting for status quo in policy rate for now and delivering a credible monetary policy that supports the economy, Patra said it is paradoxical that weak aspects of economic activity are widely cited, but every projection of growth — official; multilateral; independent — shows that it is expected to accelerate in 2017-18.

Cautioning that the financial environment is “bubbly and frothy”, the RBI ED said the combination of high valuations in equity and fixed income markets, an appreciating currency and the persistence of a liquidity overhang in the money market is a perfect recipe for financial imbalance.

A rate-cut can amplify it if the central bank is seen as encouraging risk-taking. Acharya reiterated that growth slowdown since the first quarter of 2016-17 is rooted in the stressed balance sheets of our banks and corporates in several sectors. RBI’s output gap estimates that account for financing conditions using recent modelling advances to pick up this protracted slowdown.

RBI Governor Urjit Patel felt that while the growth outlook in terms of projected GVA (gross value added) growth for 2017-18 is retained unchanged at 7.3 per cent, there are some signs of downside risks on the underlying growth momentum in industry and services.

While the frontloaded expenditure by the Central Government so far during the year has provided a boost to the economy, the Governor cautioned that the implementation of farm debt waiver by the State Governments has significantly increased the fiscal risks and poses an upside risk to the inflation outlook.

Patel said: “Effective transmission of a policy rate cut is the key to achieving the goal of supporting the non-inflationary growth.” Credit growth has also been low, partly because of risk aversion among banks on account of their stressed assets position. Resolution of stressed balance sheets of banks, therefore, will remain important for reviving credit demand and the investment cycle.”