Wednesday’s 25 basis points (bps) rate cut by the Reserve Bank of India (RBI) was more or less expected, as the central bank continued to take a hawkish stance towards inflation, which is already at its lowest ebb in recent times.
But more than a rate cut, what the economy needs is a fresh dose of fiscal stimulus in terms of subsidies or other fiscal measures. This will go a long way in pushing the gross domestic product (GDP) growth rate to 9% or 10% from the current 7% levels.
The government is in a position to loosen its purse strings by pushing the fiscal deficit target from 3.2% of GDP to 3.5% for 2017-18 without violating the provisions of the Fiscal Responsibility and Budget Management Act, 2003. With the economy already showing some amount of tax buoyancy in the first two months of this fiscal—central tax revenues have grown by 36.2% and non-tax by 4.1%—compared to the same period last year, the time is ripe for the government to act, and it should.
Here’s why the government needs to act now.
RBI’s monetary policy is ineffective on structural issues
Monetary policy has its limitations. For instance, it has little or no impact on prices. Prices of fruit and vegetables are largely driven by monsoons and logistics; commodity prices often depend on the state of the Chinese economy. There’s little the RBI can do to manage the spiraling prices of onions and tomatoes; that’s up to the government.
Declining manufacturing activity
This is by far the most worrisome. The Indian economy is facing a continuous decline in manufacturing activities, with the index of industrial production (IIP) plummeting to 0.4% in June 2017 compared to a robust 7% last June. With inflation down to 1.7%, economists worry that it could be the beginning of a deflationary economy. The latest IIP data also show that the worst performers were coal mining and cement production, both of which are vital inputs for industrial growth.
Few new
investments in capex or greenfield projects
Industrial capacity utilisation levels have fallen to
72.3% in December 2016, down from 82.3% in March 2011. Madan Sabnavis, chief
economist at Mumbai-based CARE Ratings, says in a paper entitled, Declining capacity utilization rate on
June 27, 2017, that capacity utilisation needs to move towards 80% “before
fresh investment can be invoked”. In other words, unless capacity utilisation
improves, it will be tough for industry to raise funds for capacity expansion
or greenfield projects.
Bank credit to
commercial sector at its nadir
Bank credit to the commercial sector has fallen sharply
to 38% in FY17, down from 50% a year earlier, according to the RBI’s latest Financial
Stability Report. India Inc. is tapping more into the corporate bond market and
taking the external commercial borrowing route to fund capital expenditure and working
capital needs. Even as banks struggle with poor credit offtake, the bond market
is booming with investment bankers arranging nearly Rs 1.04 lakh crore in the
April to June quarter of this year–the highest ever volume in the first
quarter. The average gap between bank loans and bond yields for top rated
corporates could be in the 100 bps to 200 bps range.
Bad loans dog
big lenders
Saddled with mountains of bad debt, public sector
banks are not reducing interest rates despite an RBI proposal to do so. Banks
face more trouble with four states announcing farm loan waivers. And if the
telecom sector, which is Rs 9.2 lakh crore in debt, begins to default, these
banks will be in an untenable position.
Falling savings
and investment rate
The savings rate and investment rate—the two major
drivers of growth in the absence of strong export growth—continue to slide. The
savings rate (ratio of gross saving to GDP) and the investment rate (ratio of
gross capital investment to GDP), have fallen from 33.1% in 2014-15 to 32.3% in
2015-16. Similarly, the investment rate has declined from 34.4% to 33.3% in the
same period.
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