WHETHER POLICY RATES SHOULD BE REDUCED TO SPUR GROWTH? SOME MUSINGS

 Dr Banshi Lal Srivastava

All stakeholders especially Economists and Bankers are awaiting as to what decision RBI takes to stimulate the economy with bated breath in the new monetary policy. We have now newly inducted members in the MPC and also a new Deputy Governor has been appointed (It is not clear whether he will be the member of the team as yet). Various surveys and opinion polls - preceding the episode, indicates that status quo on policy rate could continue. But we know sometimes Govt surprises every one through taking out rabbits from its hat so the guess could go completely haywire

In order to guess what is most likely to happen some clues could be had from the recent developments in of key macroeconomic parameters. The major elements in this direction could be overall growth scenario, Inflation, fiscal developments, challenges being posed by corona, explosive developments near LAC posing the challenge of serious border skirmish etc. The impact of various so called revolutionary changes in economic policy which could albeit be termed as fundamental reforms is another point which may not have short terms implications on the policy but could be important.

GROWTH SCENARIO

All the domestic and international financial and growth institutions are pointing out that any perceptible developments in Indian Economy could take place only in 2022 and till then we cannot initiate any remarkable step except to keep the economy floating and saving it from further slide. However, of late some optimism for the near future emerges. This is in the sense that the deep cut in the growth estimated earlier could dilute if we go by development in various components of growth. If the improvement in some of the key parameters witnessed in Sept 2020 continues and get further accelerated, overall growth position of the country could improve. It appears that lockdown decisions taken freeing the economy from shackles has started showing good results. Some major developments could be sighted as under

The PMI index has shown spectacular improvement from Sept figures. If data is to be believed, Government indicated that it is highest figures during the last 8 and half years almost. Of course some setback was observed in service PMI but the overall improvement in PMI could be considered extremely encouraging. The overall inference is that industrialists have become more positive and this could push the investment cycle.

Trade and Commerce Ministry has indicated that after a monotonic decline in the growth rate of exports during the last 6 months, it has first time now the growth is turned positive. Even the trade and industry association have also started showing optimism for the near future. Though the trade balance has been showing surplus but fall in imports has played an important role leave apart the fall in oil prices reducing the import bill.

Banking sector of course is finding it difficult as how it could show healthy growth and positivity on reduction in NPA. The credit growth remained tepid in single digit growth while deposit growth is showing double digit growth. Extension of moratorium and remission of compounding on interest paid by the borrowers are again a negative development. Banks have become sceptic in extending loans to large industries for obvious reasons. Rating agencies data again show that no of firms being downgraded are more than those being upgraded.  However Govt is well aware with the likely deterioration in banks health due to NPAs and therefore digression from earlier stand that banks should raise their resources did a somersault and has announced recapitalisation to the tune of Rs. 20,000 crores. This will obviously create greater confidence in banks.

So far as inflation is concerned it is already crossing the threshold set up by the RBI and if MPC opines that inflation would harden then it will have to explain to the Govt what is required to be done. The chances of inflation upending in future cannot be ruled out. So far as fiscal policies are concerned they are already in mess due to recession and other issues. Government continues to face the issue of keeping its debt and fiscal deficit under control to avoid any reduction in its sovereign ratings by the rating agencies. They have already indicated a grim scenario and we are only one step below the non investment grade. 

If there is any element of surprise for the economy beleaguered by all gloom and doom, it is buoyancy shown by the stock market. If defies all gravity – how come when the overall economy is showing depression stock market could show uptrend. Surprisingly today Sensex crossed record 40,000 and Nifty more than 11,700 These figures are record before covid period. For our analysis for some time we can keep it aside considering that in the economies of developed countries are flushed with liquidity due to various stimulant policies The money will obviously find the way where investors could reap handsome profit. Our stock market is known for that due to interest differentials too So unless something gravely go wrong we can expect market to remain buoyant. Any increase in interest in FED would of course could go negative but presently no clue is there

So far as Corona is concerned, if govt figures were to be believed, there appears to be positive development. The number of daily infection in terms of new cases is declining. This is against the trend witnessed in European countries where corona has comeback with a vengeance. The widely different scenario of course raises lot of doubt whether the improvement which is witnessed during the last some days could be termed as a definite proof of further improvement.

A top virologist from India has indicated confusion in the percentage figures of recovery. He indicated that detection is being done by adopting two methods Retro Antigen based. If figures from the both types of tests are available only then it will be possible to conclude that there is improvement in corona situation. It is also indicated that MIT talks that corona figures are grossly underestimated. While the figures of daily infections have reduced from 93,000 plus to now 76,000 ……the daily no of deaths have also reduced from 1100 plus to now 800-900. So we have to see whether this positive growth is converted into a secular trend.

Another issue will be impact of lockdown 5 on the virus keeping in view the situation in European country which opened their economies earlier Now the way steps are being taken to open the economy, its impact will be visible  only after some time. If the situation does not deteriorate or improved this would mean that economic growth could get accelerated.

The situation on LAC remains explosive even though of late a perceptible in Chinese blabber and threat is being observed in the face of manifestation of our military muscle power and our four friends uniting together under the leadership of US but difficult to say how things would pan out. China has deployed massive army and weapons and any small clash could result into massive war. In the wake of this situation we are regularly getting ourselves equipped with massive import of military weapons which obviously putting lot of pressures on our resources.

OPTIONS

Now after we have silhouetted the economic background, question arises which are the options from monetary policy angle? At a time when the economy has started showing green shoots as mentioned there could be two ways to look at the same.

 Should repo rate be reduced so that Banks credit deployment to give a push to the growth? Further if so why not reduce the repo rate? This obviously goes contrary to the popular thinking.

As against the above logic an important question would be that by reducing policy rates by a large percentage so far, clamouring the reduction in the capital cost so why should we tinker the rate and why not wait for some more time. Further any fall in the repo rate will obviously force bank to further reduce their margin and would result in making them more miserable at the present juncture. Even Further the boom being seen by the stock market could lead to flow of money to other countries due to increased interest rate differential

THUS WHILE IT IS DIFFICULT TO CONCLUDE FROM THE TWO SCENARIO FAR AND AGAINST IT WOULD BE BETTER IF GOVT COULD MAINTAIN THE STATUS QUO ON POLICY RATE AND ALSO IMPLYING HAWKIS VIEW THAT IT WILL INCREASE REPO IF INFLATION HARDENS IN FUTURE  

Dr Banshi Lal Srivastava

[email protected]