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.

There’s little the RBI can do to manage soaring vegetable prices; that’s up to the government.
There’s little the RBI can do to manage soaring vegetable prices; that’s up to the government.
Image : Alamy

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.

Industrial capacity utilisation levels have fallen to 72.3% in December 2016, down from 82.3% in March 2011. 
Industrial capacity utilisation levels have fallen to 72.3% in December 2016, down from 82.3% in March 2011. 
Image : CARE Ratings paper, Declining capacity utilization rate

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.

Urjit Patel, the 24th governor of the Reserve Bank of India. 
Urjit Patel, the 24th governor of the Reserve Bank of India. 
Image : Press Information Bureau 

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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