The Reserve Bank of India (RBI) Governor Urjit Patel appears to have pleased both the hawks as well as doves by cutting the repo rate by 25 basis points. This is lower than the 50 basis points cut that markets were expecting but enough to shed the hawk image that his predecessor had acquired.
However, the next few months are going to be important as they will test the Governor’s resolve towards inflation targeting, a policy recommended by the committee he had chaired as Deputy Governor. In his first policy announcement Governor Patel has clarified that the policy requires Consumer Price Index (CPI) inflation not to be targeted at 4 per cent but within a band of 2-6 per cent making it “easier” for him to meet the target.
Private consumption
“Domestic growth is currently being driven by private consumption rather than private investments,” said Rudra Sensarma, Professor of Economics, Indian Institute of Management,Kozhikode. According to him, close to normal monsoon, would help rural demand while the pay commission effect will support urban spending. There are already signs of a demand revival as evidenced by the rise in automobile sales in September last. Domestic passenger vehicle sales were up by 20 per cent (the highest in over four-and-a-half years) and the momentum in private consumption will continue with the festive season coming up. This will put pressure on prices of most commodities except food – the latter would benefit from a good harvest.
“Overall private investments remained muted due to excess capacity and high leverage across firms”, the rating agency Crisil stated in a recent report.
The rating agency’s upgrades in the current fiscal were primarily led by consumption-linked sectors such as automotive components and packaging. In contrast, investment-linked sectors such as construction, industrial machinery and real estate continued to dominate downgrades led by business-related reasons such as sluggish demand, stretched working capital cycles and pressures on profitability.
The fall in private investments was also in sync with the continuous decline in the production of capital goods, which weighed down the Index of Industrial Production (IIP). Exports remained weak with major markets such as the European Union, the U.K. and the U.S. continued to grapple with sluggish growth.
Significant headwinds continue in exports with the World Trade Organisation sharply revising its global trade growth forecast to 1.7 per cent from 2.8 per cent. S&P Global, too, has revised its growth outlook downward for India’s major trade partners for 2016 and 2017. “That would mean not much improvement in India’s exports in the current fiscal.”
Crisil added that sustained industrial recovery is not yet on the horizon as indicated by the IIP, which declined in the first half. “So credit quality, especially for investment-linked sectors remained under pressure.”
Sluggish capex
With a debt-laden corporate sector struggling to invest in fresh projects the government has had to shoulder the responsibility of reviving the capital expenditure (capex) cycle. The RBI’s latest monthly bulletin (September 2016) suggests that capex by the private corporate sector, estimated at Rs.1.51lakh crore in 2015-16 was 24.7 per cent lower than the revised estimate for 2014-15. Even to maintain this lower level of aggregate capex 2016-17, an amount of Rs.83,800 crore needs to come from new investment intentions of the private corporate sector in 2016-17.
“This sounds like a tall order. Unfortunately, the government is not in a position to pick the tab,” said Prof. Sensarma. The recent double whammy from poor spectrum sales and disappointing collections from the income disclosure scheme is putting pressure on the Government’s fiscal deficit target. In fact, during April-August, fiscal deficit had already crossed 75 per cent of the full year target of 3.5 per cent.
U.S. Fed Rate
It is not only the upside risks to inflation that will test the RBI governor but what the U.S. Fed decides to do in December with its interest rates. Factory output has expanded in September and the economy added 1.56 lakh jobs in the U.S. “Most commentators are expecting a hike in the Fed fund rate which will put pressure on the rupee and increase our import costs,” said Prof. Sensarma, adding, “with crude oil prices showing some signs of reversal (upward) this may create trouble for the current account deficit.” Crude oil price is reaching the US$ 50 per barrel mark for the first time in several months.
Bottom-line
Banks are not in a position to pass on interest rate cuts in spite of the Marginal Cost of Funds based Lending Rate (MCLR) regime (up to March 31, 2016, banks used the base rate as the benchmark rate to lend). At least, they are not expected to transmit lower rates to borrowers till their own non performing assets (NPAs) come down significantly.
RBI data shows a decline in food credit by 23 per cent in 2016-17 so far and growth in non-food credit only by 0.1 per cent. One alternative, according to Prof. Sensarma, is to ensure that monetary policy transmission is led by other channels such as corporate debt and demand revival which will have to be supported by means such as easier procedures, faster clearance and foreign investments.
In fiscal 2016, there was a sharp increase in slippages to non-performing assets (NPAs) because of higher-than-expected deterioration in corporate credit quality. Crisil said asset quality pressures are expected to continue in fiscal 2017 as it expects around Rs 2.1 trillion of corporate stressed assets (from the top 100 exposures of all banks) turning non-performing by March 2017.
The rating agency also expects overall slippages in the banking system to remain high at 4.2 per cent - or Rs.3.3 trillion - for this fiscal, and gross NPAs to increase to 8.5 per cent -- or Rs.7.5 trillion. Further, weak assets are expected to remain high at 9.6 per cent or Rs.8.6 trillion as on March 31, 2017 (around Rs.7.4 trillion as on March 31, 2016).
