The time’s ripe for a rate cut

Like all major economic reform initiatives, the de-legalisation of the high value notes announced by Prime Minister Narendra Modi recently has to be followed up by quick action on other fronts so that the gains are not frittered away and are transmitted to the common man fast.

Anecdotal evidence suggests that the people queuing up and undergoing hardships to exchange currency across the country are generally supportive of the objective of this bold and unprecedented move because they believe this will be good for the nation.

But it is also true that small businesses and trading have been affected with turnover coming down sharply in the markets.

Cash will continue to be king as far as the daily transactions of crores of our countrymen are concerned, especially in the rural and semi urban centres with payments for groceries, vegetables, milk and wages for farm workers and labourers being done only in cash.

Though the banking system has coped remarkably well with the demands placed on it, the prospect of a slowdown till March, 2017 remains a cause for worry.

Already a couple of major brokerages and forecasting agencies have put out reports predicting a lower GDP growth in the second half, with some estimates putting it lower than 7 per cent. Whatever the variations in the assessments, there is indeed an urgent need to send out pro-growth signals and see that the Government’s move does not affect earnings, consumption and employment.

It will have a great demonstrative effect if a quick response comes from the Monetary Policy Committee of the RBI. The MPC is mandated to “maintain price stability, while keeping in mind the objective of growth”. At the present juncture, growth considerations should override concerns over inflation.

Inflation as measured by the Consumer Price Index had come down to 4.2 per cent by October-end itself. It is a no-brainer that the November CPI is likely to be below 4 per cent, as consumer demand has been adversely affected by the de-legalisation of the old high value notes. Prices of fruits and vegetables have fallen drastically. A check in Hyderabad’s largest market at Gudimalkapur indicated that prices of potato, onion, tomato, green chilies and brinjals have crashed (not necessarily a good outcome, especially for farmers). Food and beverages have a weight of 45 per cent in the CPI.

The Government had set the inflation target in its August 5, 2016 Gazette notification for the period ending March 31, 2021, at 4 per cent with a tolerance of 2 per cent for the MPC. Also, in its last meeting on October 3 and 4, the MPC had stated that its decision to cut the repo rate from 6.5 to 6.25 is “consistent with an accommodative stance of monetary policy in consonance with the objective of achieving consumer price index (CPI) inflation at 5 per cent by Q4 of 2016-17”.

Given the certainty that inflation is likely to trend around 4 per cent in the next two quarters and growth may be a casualty in the near term, a repo rate cut of 0.5 per cent is a booster that is urgently required. (Of course, as monetary policy affects growth with a lag, fiscal stimuli may also be required for growth.)

Other indicators also make the case for an immediate cut self-evident. The 10-year G-sec rate which was at 7.68 per cent in January, 2016 is now at 6.55 per cent. State governments which borrowed money at about 8 per cent in March, 2016 can now raise 10 year loans at about 7 per cent. Call money, which was 7.20 per cent in January, is now at 6 per cent and the one year dollar-rupee premium has come down to 4.68 per cent from 6.10 per cent during this period.

A repo rate cut now will be just formalising the inevitable and will be ahead of the curve. It will be seen as one of the instantaneous results of de-legalisation and temper the hardships, especially of the micro, small and medium enterprises, by lowering their borrowing costs. Banks which have seen a huge deposit surge will be forced to cut lending rates, even though not all inflows are likely to stick.

This will also lead, sooner than later, to still lower housing and car loan rates, which will have a positive impact on housing demand and neutralise at least partially, the realty slowdown anticipated by many.

More importantly, such a before-the-due-date cut will denote what de-legalisation means for the common man immediately -- lower borrowing costs. And it will blunt the criticism of the nay-sayers who miss the ground-breaking reform potential of the Prime Minister’s November 8 announcement.

The writer is Chief General Manager with State Bank of India. The views are personal