Interest rates to stay high, few growth drivers in sight
Given the Urjit Patel committee report’s recommendation that RBI move towards CPI-inflation targeting, and the fear that the Fed taper decision late tonight may further aggravate investor appetite for emerging markets, RBI Governor Raghuram Rajan’s decision to hike repo rates 25bps—this takes the hikes under his watch to 75 bps—wasn’t entirely unexpected. With Rajan having accepted the Patel report’s recommendations, without explicitly saying so, the question is whether there will be an interest rate pause as RBI has indicated by saying “further policy tightening in the near term is not anticipated at this juncture”. Given RBI’s view that “there are upside risks to the central forecast of 8 per cent”, it is likely interest rates will be hiked again over the next two to four months. More so since, an 8% CPI target means non-food CPI inflation needs to come down to 6% levels, from 8.1% right now (April to December 2013)—and that’s assuming food inflation falls to the 10% levels it has been at for the past 8 years though actual Apr-Dec food inflation has been 11.8%. And, as this newspaper has argued before, inflation-targeting is an out-of-fashion and problematic idea since the rate hikes it entails can have serious consequences. The Urjit Patel 6% CPI target over the next two years means non-food inflation has to come down to 2%—that’s once again assuming CPI food inflation remains at 10%. And if deficits don’t remain under control, or the government continues to play havoc in labour markets with MGNREGA for instance—these are pre-requisites of the Patel report—the extent of interest hikes will be even more severe.
Even more worrying is the growth scenario. While RBI’s forecast is for a 5-6% GDP growth in FY15, up from sub-5% in FY14, it is not quite clear what the growth drivers are going to be. RBI blithely assumes, for instance, that several of the projects cleared by the Cabinet Committee on Investments will start coming on stream—yet, the fact is that most of these investments were planned at a time when India’s 9% growth looked like it was going on 10, or around double the current rates of growth. Which is why, despite the Rangarajan committee coming out with its bailout plan for highway projects—pay for the shortfall in premia at bank rate +2%—very few firms are actually enthused by the proposals. Equally, with much of India Inc highly leveraged, the chances of it being able to raise either the debt or the equity required for fresh investment is low. At a macro level, from a high of 17.3% of GDP in FY08, corporate sector investment is down to just 10.6% in FY12—since this is the growth driver, in the absence of a significant boost here, GDP growth simply cannot rise to meaningful levels. A fall in corporate sector investment levels of this magnitude, JP Morgan’s India chief economist Sajjid Chinoy points out, suggests the economy’s productivity has gone down, as has the output gap—in which case, any growth acceleration can trigger off another bout of inflation. Regardless of how one views Tuesday’s rate hike, it remains true that till the investment climate is restored, India’s growth-inflation dynamic is going to be tricky.