Rajan Plays Cautious but is Upbeat on Growth Later Down the Year

RBI monetary policy gives food for thought not just to the market but also to policy makers, writes Shishir Asthana

Not ruling out a rate cut in the future, RBI Governor Raghuram Rajan has given enough fodder to the markets. (Photo: Reuters)

A Mixed Bag

• Enough hints in the policy statement which portray a positive picture for the country going forward
• Good news is that the RBI governor says that the economy will pick-up from the third quarter of the current fiscal
• Monsoon along with the government’s cooperation will go a long way in determining RBI’s course of action

Markets have not received the RBI’s continuing stand well. (Photo: PTI)

Markets initially responded negatively to Reserve Bank of India (RBI) Governor Raghuram Rajan’s decision of keeping interest rates unchanged. Though few analysts believed that the governor would reduce rates, his continued cautious stance has not gone well with market participants.

At a time when global economies are testing every possible method to revive growth, RBI’s stance of curbing growth by keeping interest rates high has brought criticism at the central banker’s door. Low inflation on account of poor growth and low oil prices is a small window of opportunity, which some economists feel RBI is missing out on. In fact, the governor in his policy statement said that the advantage of high base effect for inflation will go away from September onwards.

To his credit the governor has already reduced interest rates by 75 basis points (100 basis points is equivalent to 1%) but banks have passed on only 30 basis points. When the governor announced the previous interest rate reduction of 25 basis points he had clearly said that future reductions will be based on fuller transmission by banks of the rates. Announcing another rate cut would have served little purpose if the banks are not willing to pass on the earlier ones.

However, despite the general negativity, the governor’s statement is bullish on various counts, both for the markets as well as the economy. There are enough hints in the policy statement which portray a positive picture for the country going forward. For the markets, they also offer insights into which sectors are likely to do well.

Work-in-Progress

Let’s first take the case of when bankers will be comfortable in passing on the rate cuts. Rajan said in the policy statement that “As loan demand picks up in Q3 (third quarter) of 2015-16, banks will see more gains from cutting rates to secure new lending, and more transmission will take place.”

There are two reasons to be happy in the above mentioned statement. First is that the governor says that the economy will pick-up from the third quarter of the current fiscal and second that banks will cut interest rates, which can lead to further cuts by the central banker.

On credit off-take the governor has pointed out that despite the high interest rates, bank credit growth adjusted for lower inflation as well as for lower borrowing by oil marketing companies, and borrowing shifting to commercial paper markets, is good. Credit availability seems to be adequate for most sectors, says Rajan. Further, the government’s decision of pumping in equity in public sector banks will also help increase lending by these banks, points out the policy statement.

On the economy front, Rajan has pointed out that the economic recovery is a ‘work in progress’. There are signs of growth in consumption demand, in urban areas, says the policy report. Car sales have been strong and traffic movement in the economy has picked up. Rajan said that a pick-up in heavy commercial vehicle sales and rising port and domestic air freight in the first quarter suggest strengthening transportation activity, which are signs of under-current movement in the economy.

The policy document says that monsoon has been normal till date. This combined with higher reservoir levels augurs well for the kharif crop output. (Photo: AP)

Determining Factors

Agriculture growth, which both the government and the central banker had assumed will be low at the start of the year on account of poor monsoon, might spring a surprise. The policy document says that monsoon has been normal till date; this combined with higher reservoir levels augurs well for the kharif crop output. Importantly, the kharif crop sowing has expanded significantly relative to last year, especially for oilseeds, pulses, rice and coarse cereals. Companies catering to the agriculture sector and the rural market might see some activity.

The policy also highlights the sectors that are not expected to do well. Exports in some industries on account of the weak global demand and overcapacity, and also due to the currency depreciation of some major trading partners, have contributed to weak aggregate demand. With no signs of significant uptick in global economies, export oriented companies, especially those which are already hit, may remain under pressure.

Rajan also pointed out that capacity utilisation is low, investment in new projects is weak and the good work done by the power ministry in addressing fuel supply has been negated by the poor health of power distribution companies.

But the undertone of the policy statement is that growth is improving gradually and if government gets its act in order, monsoon continues to be good and banks support the economy by reducing rates, RBI will not deter from reducing rates further.

In fact, in the press conference Raghuram Rajan said that he is not ruling out a mid-policy rate cut. Now that’s the carrot the market will chase going forward.

(The writer is a Mumbai-based market analyst)