With RBI and govt poles apart, things just got worse
RBI cutting its growth estimate for the second time in four months is bad enough—it first revised the 7.3% target to 6.5% in July and has now lowered it to 5.8%—but the data provided by it in the second quarter review yesterday suggests RBI may have occasion to revisit the estimate again. So, RBI points out, industrial activity in April-August grew just 0.4% this year as compared to 5.6% in the same period last year, kharif output will be 9.8% lower than last year’s record output, capacity utilisation in industry is at a 13-quarter low, year-on-year sales of India Inc have decelerated over the last 3 quarters, money supply grew just 13.3% as compared to the 15% target and funds flow to India Inc (including that from overseas) was 6% lower than it was last year (data till October 5) in even nominal terms.
Given this, and the data on two-wheeler and commercial vehicle sales for instance, it’s pretty clear aggregate demand is low—on a sequential basis, data till Q1 show aggregate demand has fallen by 6.5% in real terms. Assuming the same holds for Q2, the only explanation for inflation remaining stubborn is structural weaknesses that RBI is probably compounding, but is not solely responsible for. Top on the list, of course, is the near-standstill in investments, best illustrated by the fact that SBI’s April-August project finance collapsed to a tenth that of last year. There are then issues like the shortages in coal and gas that have ensured even existing plants are not able to run well—BHEL’s order-book collapse signals this while L&T’s robust book suggests expenditure on urbanisation projects (metros for instance) is gathering pace. And there is obviously the large inflation that is coming from overseas, mainly from the lack of confidence foreigners are showing in the rupee, though that improved for a bit.
This is where what the finance minister said about walking alone comes in, though it is not surprising that RBI Governor Subbarao didn’t take his deficit reduction promises seriously—as compared to a fiscal deficit target of 3.6% of GDP in FY07 as part of the original FRBM plan, the FM has now promised this in FY16. While Subbarao ducked the question of what the impact of a rate hike was on investment levels, it is significant, especially for smaller firms. In the case of infrastructure, according to Goldman Sachs research, when SBI’s prime lending rate fell in 2009, L&T’s PE ratio increased dramatically—it’s difficult to remove the GDP impact from this, but clearly that’s a significant re-rating.
On balance, though that does not absolve RBI for not cutting the critical repo rate, the work ahead is primarily that of the government. It needs to activate the National Investment Board to get projects cleared, bottlenecks like Coal India have to be fixed. And given how the sharp hike in rural wages contributes to hike in overall wages—and inflation—the government would need to look carefully at policies like hiking agriculture support prices as well as the MGNREGA. The interesting question for Subbarao is that if inflation is to rise in Q3, as the second quarter review says it will, how will he justify a rate cut in January?