Rate cut — if not now, when?

Last Tuesday, in a surprise development, eight States like Kerala, West Bengal, Punjab and Rajasthan raised about ₹7,700 crore worth of their 10-year Development Loans at a maximum coupon of 8.10 per cent, much below the market poll expectation of 8.20 per cent, announced just hours before the auction. What led to this windfall (lower cost of borrowing) for States in general and that too for some, whose finances are not exactly in the best of shape?

After finance minister Arun Jaitley’s tremendously clear-headed budget for FY 2017 and his subsequent bold move of cutting small savings rates, the Government securities market has seen a rally, primarily predicated on his sticking to the targeted fiscal deficit levels both for this year and the next.

The yields on securities and money-market rates like those on Certificates on Deposits had remained stubbornly sticky, till February 29, despite the rapid repo-rate cuts by RBI.

And then, the tide seems to have turned, thanks, in the main, to the initiatives of the Union Government. Yields have eased and the coupon on inter-bank borrowings has fallen. It must be acknowledged that the Open Market Operations of the RBI and the Union Government (a first in recent times) have also helped.

With this, the ball is now well and truly in Mint Street’s court, as far as interest rates are concerned. “The Finance Minister and I do not sleep in the same city!” that doyen of central bankers, YV Reddy had famously said in his time, when asked about differences of perception between the RBI and the Government on interest rates.

Continuing in the same tradition, the last bi-monthly monetary policy statement of governor, Raghuram Rajan had concluded that “the current momentum of growth is reasonable, though below what should be expected over the medium term. Underlying growth drivers need to be rekindled to place the economy durably on a higher growth trajectory. The revival of private investment, in particular, has a crucial role, especially as the climate for business improves and fiscal policy continues to consolidate.

The Indian economy is currently being viewed as a beacon of stability because of the steady disinflation, a modest current account deficit and commitment to fiscal rectitude. This needs to be maintained so that the foundations of stable and sustainable growth are strengthened.

The RBI continues to be accommodative even as it leaves the policy rate unchanged in this review, while awaiting further data on the development of inflation. Structural reforms in the forthcoming Union Budget that boost growth while controlling spending will create more space for monetary policy to support growth, while also ensuring that inflation remains on the projected path of 5 per cent by the end of 2016-17”.

If the final line of governor Rajan is reckoned as necessary and sufficient conditions to be fulfilled by the Centre for a further rate cut, then those have been unambiguously met. Jaitley and Arvind Subramanian have delivered on their promises. So, the question that obviously arises, regarding a repo rate cut by RBI, is quite John F.Kennedyish: “If not now, when”?

One fifth of the world’s GDP is now constituted by countries which have opted for negative interest rates. Quite conspicuously, the ECB reduced its negative rate further to minus 0.4 from 0.3 per cent on March 9. The Bank of Japan governor Haruhiko Kuroda cut interest rates to below zero early this year. And last month, in her semi-annual testimony to Congress, Federal Reserve Chairwoman, Janet Yellen said, “We wouldn’t take those off the table, but we have work to do to judge whether they would be workable here,” when asked about her views on negative interest rates.

It is an irrefutable fact that global growth is slowing down. Deflation is staring at the face of large swathes of the global economy. Our exports have consecutively fallen for 14 months in a row. Therefore, our domestic demand/growth needs all the support that it deserves.

And the recent Asset Quality Review exercise of RBI, though good in intent and content, has an anti-growth bias, at least in the immediate term, in my opinion. One of the most venerated voices in Indian banking, Arundhati Bhattacharya, also the State Bank Group Chairperson, has already articulated the view that risk appetite will be down given the huge increase in NPAs.

On the other hand, inflation is on the glide path, going by the CPI monitor. India’s central bank has done an admirable job of keeping inflation under check. A publicly-stated commitment has also helped. As Kaushik Basu (currently chief economist with the World Bank) said in a seminal working paper in 2011 (Understanding inflation and controlling it), “It is widely believed and is arguably true that when a well-informed responsible government or quasi-government agency makes an inflation forecast that, in itself, can cause the course of inflation in the future to change.

This is because, at least in the short run, the actual inflation rate depends, in part, on what people expect the inflation rate to be... Prices can be stabilised, to a certain extent by virtue of leading people to expect that prices will be stable”.

Further, according to Basu, in tracking the repo rate and inflation it is immediately evident that, while there is some connection between the two, especially with some appropriate time lags put in, there is also a lot of noise.

“The management of inflation cannot be reduced to a mechanical engineering problem, where the formula connecting what is to be done by the government or the RBI and what will be achieved is written in stone,” he had said.

And in any case, Mint Street has no control over what tur dal or urad dal will sell at. Both have seen 100 per cent price increases over the past 12 months even as we take comfort from the “glide path”! My driver, Anil, moans about the fact most vegetables that he buys have seen price rises in Thiruvananthapuram of 30-40 per cent in the last two months. It is estimated that the poorer quintile of the population devote approximately 60-70 per cent of its consumption to food.

The repo-rate can never influence the prices of articles of essential consumption like food grains, pulses and vegetables, (supply-side biased) and this is what inflation is all about, for the man on the street.

Growth impulses need to be supported unreservedly. So, an aggressive — not incremental — cut is what the hour demands. This will also be perfectly in alignment with the sound monetary and regulatory responses that governor Rajan and company have come up with so far.

The writer is chief general manager, SBT. The views are personal