Cutting edge

In what seems to be turning into a Raghuram Rajan trademark, the RBI has, for the second time this calendar year, cut the repo rate before its scheduled monetary policy statement. The timing of the second 25 basis point cut in 2015 cannot be faulted and the move signals to the investing community that fiscal and monetary policy actors are on the same page. It also provides a feel of how the envisaged committee-driven monetary policy framework will work. Now, both fiscal and monetary policy are accommodative by design. The Centre, realising a window of opportunity provided by a subdued current account deficit, the sustained dip in oil prices, low inflation, and 10-year yields at 7.5 per cent, has decided to ramp up capital expenditure. Crowding out does not seem likely, with private investment yet to pick up. Yet, there can be no denying the green shoots, with the economy growing this year at 7 per cent. Green shoots require watering, and that explains why Rajan got into the act within days of the Budget, rather than stand on procedural niceties.

All the same, it is important to keep in mind that the somewhat fortuitous combination of favourable factors may not exist, say, six months from now. While inflation at 5 per cent is well below policy expectations, there are indications that the second half of 2015-16 may look different. The effects of the Railway Budget, which has raised rates on coal, steel, grains and pulses, may start to kick in. Add to this a few more rounds of fuel price increases, and we could see a spurt in transportation costs. Any fluctuation in agriculture output could complicate matters. Since the goal is to restrict inflation to 6 per cent by the end of 2015-16, with the Centre committed to an investment stimulus at least till private investment picks up, the onus of adjustment may fall on the monetary side.

The moot point is whether banks pass on the repo rate cut. For banks to lend proactively, they will have to recover their NPAs. A revamp of existing bankruptcy laws, as articulated in the Budget, will help this cause. However, in keeping with the Budget spirit, small producers deserve a special credit line, independent of the overall NPA situation. This will ensure quicker monetary transmission, setting up a growth momentum so that a situation of creeping price rise does not derail the economy. Banks need to arrive at a ‘golden mean’ between revival and restructuring on the one hand, and the very logic of lending on the other, so that economic recovery does not remain stillborn. Besides easier lending rates, there should be no let-up in other efforts to ease the conduct of business. Monetary policy can only have a limited impact in an economy where credit outstanding is about half the GDP. The push has to come from supply-side reforms and a fillip to infrastructure. There are positive signs of a coordinated effort in this direction at the top.

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