With the August Monetary Policy Committee review just around the corner, the debate is once again open over its next course of action. We expect a 25 basis points cut to be announced after the meeting, for both domestic and international reasons.
At home, Consumer Price Index (CPI) inflation has undershot projections for the past six months. Base effects aside, sequential increases have been muted. June CPI inflation eased to 1.5 percent year-on-year, from May’s 2.2 percent – falling below not just the central bank’s estimate of 2-3.5 percent but below its target range of 2-6 percent as well.
Inflation expectations have been moderating, with a normal monsoon and a small rise in minimum support prices also expected to temper food prices.
Concerns remain over the impact of the Goods and Services Tax (GST) and increased allowances – particularly towards housing rent.
We expect the GST changes to have a modest dampening impact on prices (20-40 basis points), while the Reserve Bank of India had signalled that it would look past any one-off lift from rent allowances. The central bank estimates some 36-150 basis points of higher headline inflation spread over many quarters.
While the stage is set for monetary easing, the bigger question is whether this would lift investment growth.
We suspect it would not.
Two observations are noteworthy here. Firstly, despite the sizeable 175 basis points worth rate cuts in the past two years, credit growth has failed to accelerate. Bank lending growth has instead slowed to 5 percent year-on-year in May 2017 from 9.5 percent year-on-year in January-March 2015.
Among the sub-sectors, credit growth was weakest with industry players and corporates and strongest from households.
A turnaround does not appear to be on the cards as yet.
The declining ability of corporates to repay loans has crimped banks’ balance sheets; non-performing loans are now equal to 9 percent of total advances (12 percent, if stressed advances are included).
Regulators have shown an urgency to address the problem but resolution takes time. In the meantime, the need will grow for higher provisioning and increased capital support. This will restrain banks’ willingness and ability to lend in the short-term.
With twin balance sheet deleveraging still to run its course, the pass-through of lower funding costs to credit growth is likely to be muted. This, however, does not diminish the need to lower rates.
A two-pronged approach is necessary: the central bank taps a benign inflation outlook to lower rates while deleveraging is pursued by corporates and banks. As the latter proceeds, growing demand from the private sector will take advantage of lower borrowing costs to lift investment.
(This article was first published on BloombergQuint. The author Radhika Rao is an economist at DBS Bank, Singapore. This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)
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