Gold Silver Reports — Dr Patel is No Yes Man, Rate Cuts may Trigger a Growth Boom — Comparisons are always odious, but it is difficult to escape one when the incumbent at a central bank is a successor to a high-profile, flamboyant and successful governor like Raghuram Rajan. Three years ago, on September 4, expectations were very low when Raghuram Rajan took charge amidst a cratering rupee and battered investor sentiment. He corrected it with a series of bold, imaginative steps that immediately restored confidence and set the stage for the bull market that was to follow.
But cast your mind back to his first monetary policy which happened a few weeks later in September of 2013 and you will see some similarities in the decisions taken by Dr Rajan and by Dr Patel.
Expectations were very high in the run-up to the 2013 policy , but Dr Rajan did not meet them. He was widely expected to cut interest rates given the Congress government’s political compulsions and a stuttering economy . Not only did he raise rates, he went one step further and began the process of incubating a new inflation fighting framework that made monetary policy subservient to an inflation target, a novel and unprecedented step for the country and its central bank. Dr Rajan’s first rate cut was in January 2015 when inflation was already falling and wholesale price index was edging into negative territory .During his term, he cut rates by about 150 basis points and he was bitterly criticised for being behind the curve and not doing enough to spur growth.
Dr Patel’s first policy was also pre ceded by similar high expectations.The novelty of the monetary policy committee had a role to play but it was his excessively low-profile nature and the enormity of the task in front of him that triggered a compulsive buzz about Tuesday’s late afternoon announcement. Dr Patel and the MPC did not disappoint and the unanimous decision would seem to suggest that the committee considered rate cuts as imperative.The stance has been broadly praised though some critics have attacked the RBI by saying that it is toeing the government line.
Two points have particularly irked the critics. The decision to lower the target for real rates to 1.25% from 1.5% and the interpretation of the inflation target as a range between 2% and 6% instead of a strict 4% as probably envisaged by Dr Rajan.Japanese brokerage Nomura criticised the 25-basis points cut by saying that it is not justified on economic grounds as inflation expectations have risen and that core inflation is still sticky. Nomura further cast doubt on the sanctity of the new real interest rate number of 1.25% saying that it could well be lowered even further. Since rate cuts are as much a political as an economic tool, social media critics have also blasted the governor for being the Modi government’s `yes man’.
A major point being missed here is that the MPC and Dr Patel are fully within their powers to not only lower the real interest rate target but also put the inflation target in a proper perspective. Raghuram Rajan’s RBI announced real interest rate target of 1.5% and there is nothing to suggest that his successor Dr Patel cannot change it if he so wishes. We will have to wait for Dr Patel to explain the thinking behind this but there is little point in jumping to the conclusion that it is mala fide.
Secondly , the amendments enacted to the RBI Act which paved the way for the MPC in no way fixed a rigid inflation target of 4%. In fact, the government of India press statement on appointment of three external members clearly states that the target is a band, with an upper tolerance level of 6% and a lower tolerance level of 2%. Also, this target is valid till March 31, 2021, and not just till 2018.
The argument that the governor and the MPC have `reinterpreted’ this target as a band is not valid. The government’s own public notification treats it as a band. Now, Dr Rajan may have clearly wanted this target fixed at 4% but that is not a part of the RBI Act.
Leave the polemics aside and let’s now look at the possible reasons behind the decision. Clearly , India is now a two-speed economy . Services, which contributes more than 50% to GDP is growing fast and so is manufacturing if you go by latest GDP data. Private investment is struggling, which is showing up in sluggish order book and tepid steel consumption. The rural economy was a big drag last year but is showing enough signs of a turnaround thanks to the near-normal monsoon. Two-wheeler and tractor sales are already picking up and car sales are booming.
The governor probably thinks that strong urban consumption trends and reviving rural economy could create enough of a demand boost for companies to start thinking of new capacities by next year. Given that global trade is a big drag, he thinks that lower rates would help in boosting investment and consumption given that much of the battle against inflation has been won.
Clearly , Dr Patel is also gambling.On the RBI and the government’s ability to handle inflationary spikes, and on banks cutting rates to boost consumption. Dr Subbarao gambled on a cut in rates in 2012 and lost; Dr Rajan gambled on keeping rates high to fight inflation and won.Dr Patel is betting that the everwatchful, unsleeping owl (as he described central bankers) will ensure not only growth but also sustain the battle against inflation. If current economic trends continue, he may well have fired up the engine that could take Indian economy to greater heights. — Neal Bhai Reports