Since the government no longer leaks information to the press on what is about to happen, it is tough to figure out whether the unanimous decision to hold the repo rate at 5.15 per cent by the Monetary Policy Committee (MPC) on December 6 has the Union government’s blessings. Maybe this is not the blow for RBI autonomy it is being made out to be and aligns with what the government wants.
It is noteworthy that a member – Professor Ravinder H. Dholakia – a rate reduction hawk-like economist Surjit Bhalla, had voted two months ago in October for a reduction of 40 pp when the decision was to reduce it by 25 pp, has this time around succumbed to the consensus decision.
Mild-mannered IAS officers have a way of growing into the core of the job assigned to them never mind that they were shoe-ins at the time they are appointed. T N Seshan, who passed on last month, was a compliant but very effective bulldog, who rescued the Election Commission from obscurity as Chief Election Officer in the early 1990s.
Ashok Lavasa, a current Election Commissioner has similarly acted per his conscience in a few high-profile election cases in 2019 – an unusual occurrence, since all governments demand complete obedience from its appointees – Lavasa was Finance Secretary, before joining the Commission in January 2018.
So, has Shakti Kant Das thrown off the shackles he is presumed to have come with?
Irrespective of the politics behind the decision – one significant win is the demolition of an unfortunate impression that the only way forward for the repo was downwards thereby leading to one-way bets. The RBI decision to hold-off repo reductions will signal that it should not be taken for granted.
But the loose rudder the RBI has on inflation and growth is shocking. That the RBI was as clueless as to the government that Q2 FY 2020 would reveal a hole in demand and growth as recently as October when it signalled an “accommodative” stance on top of the rate reduction, is worrisome. There must be someone to shout, “The Emperor has no clothes!”
How much space the RBI will have to resume Repo reductions in future will depend upon the level of inflation in H2 this fiscal. The current estimate of the RBI is of less than 4 per cent inflation through till the end of FY 2021.
If inflation is expected to remain within a target, why then the hesitation to cut rates? One reason could be that bank retail loans are now Repo linked and banks are obliged to pass on rate reductions. Downward reductions in Repo hit at the existing margins of banks.
Publicly owned banks need to up their earnings if they are not to depend on government for the Rs 1 trillion needed to shore up their coverage ratio against existing and potential NPAs, subsequent to the NBFC partial meltdown. Maintaining the Repo rate makes sense from this point of view.
With increasing levels of uncertainty all around there is scattered demand for additional loans at commercial rates – the average lending rate of banks is above 10 per cent – particularly from the existing players in a large industry, who can opt to borrow abroad at interest rates at least 4 percentage points lower.
The strong INR policy reduces the risk from such borrowings for foreign lenders. It is no one’s case that India should attempt a China-style administered devaluation. But at the very least the existing high real exchange rate should be rationalized.
Our over-valued exchange rate hurts domestic manufacture by making imports cheaper and kills exports by making them more expensive. It also hurts tourism development in India by making the destination more expensive for foreigners and makes foreign vacations and foreign shopping cheaper for the affluent Indian.
As per RBI the real exchange rate index was at 109 – lower the index value, the better for trade competitiveness- in May 2014. In 2017 it increased to between 120-124 before declining to 119 in October 2019. The INR remains overvalued by 10 per cent.
The official position, possibly, is that a weaker INR would make oil imports more expensive- we import 75 per cent of our requirement – thereby triggering inflation. Similarly, the landed price of weapons and defence equipment will become more expensive.
In the case of petroleum products, the Union and state governments earned Rs 5.5 trillion (FY2017) from tax, duties and levies. This shows that the problem is not of stoking inflation but of reducing the windfall tax revenue of the Union and State governments from petroleum and spending more on all imported equipment and goods.
Regulating the foreign exchange rate to reflect a real equilibrium between demand and supply is appropriate, despite the inevitable changes in business models associated with imports or exports, because it automatically quantifies the real cost of imports and the real benefits of lost exports to the domestic economy.
Possibly, the RBI has also deferred the rate cut because no one knows which way the government will jump to escape the perfect storm of a weak and declining economy; inadequate fiscal firepower to stoke growth and the tapering-off of the beneficial effects of the 1991 reforms, two decades later, by the overhang of inefficiencies left to fester in the land and labour markets; a colonial-style bureaucracy and unresolved sticking points in key economic inputs like electricity distribution, water usage and supply and the waste in subsidizing production inputs, including subsidized interest on loans
One year down the road, governor Das is coming into his own. He has done well to wait till government reveals its cards during the February 2020 budget, whether it intends to muddle through by being recklessly profligate or whether it will drastically constrain expenditure – particularly for the military and low priority schemes which have flourished.
A cautious, balanced budget could allow the Repo rate to reduce further. A spending spree would have the opposite effect. Urjit Patel would have approved.
This commentary originally appeared in The Times of India
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Sanjeev S. Ahluwalia has core skills in institutional analysis, energy and economic regulation and public financial management backed by eight years of project management experience ...
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