RBI policy: No need to overreact, slowdown could be a temporary blip

GDP growth
The gross domestic product (GDP) growth for the first quarter of the financial year (FY) 2018, coming in at 5.7 per cent, was a shocker. Going by the present trends, the actual growth rate for FY 2018 would fall far short of the RBI’s projection of 7.3 per cent and is likely to be somewhere near the lower band of Chief Economic Advisor (CEA) Arvind Subramanian’s growth projection of 6.75 to 7.5 per cent. In the short-term, achieving the fiscal deficit target of 3.2 percent of GDP would be challenging. Job generation, tax revenue and public expenditure program,es depend on revival of growth. So, what should be the policy response to this growth slowdown?

Let us look at the issue from a longer time horizon. During 2003-11, India’s GDP grew by a record 8.4 percent. The Great Recession of 2008 didn’t impact India much. The Indian economy staged a ‘V’ shaped recovery after the minor dip in 2008-09. India’s growth rate for the 7-year period between 2011 and 2017 is only 6.65 percent and worse, trending down.

The present downturn in the Indian economy has come at a time when global growth is recovering. If global growth continues to improve and the domestic growth continues to falter, that would be a serious concern. Present indications are that the growth slump is a temporary blip caused predominantly by the impact of demonetisation and GST-related disruptions. 

Leading indicators signal recovery

Some leading indicators suggest that growth is recovering. For instance, automobile salein August is an all-time high. Passenger vehicles, commercial vehicles and two wheelers have posted impressive double-digit growth. Particularly, the commercial vehicles sales growth at 27 percent is a very positive indicator of recovery. Another major positive is the turnaround in exports, which have recovered to 10.29 percentin August from 3.94 and 3.4 percent in July and June respectively. If this trend in auto sales and exports sustains in the coming months, that would augur well for recovery in the second half of FY 2018. 

It is important that higher growth should be achieved with macro economic stability. Stimulus – both monetary and fiscal – has a cost. India’s macros are stable now. This macro stability - lower fiscal deficit, lower current account deficit and moderate inflation - achieved with commendable monetary and fiscal effort should not be frittered away through knee jerk reaction to stimulate growth. A major stimulus should wait till the Q2 GDP figures and other data like September auto sales and September exports. If these figures indicate recovery, the stimulus should be moderate.  

There is only limited room for interest rate cut. Inflation in India, though moderate, is rising and the US Federal Reserve is on a tightening mode. In this context a 25 bps cut in policy rate is the maximum that can be done. Perhaps, the RBI can do more on the exchange rate. The rising rupee has been hurting exports and causing import substitution thereby impacting domestic manufacturing. India cannot sustain a growth rate of above 7 percent without double-digit export growth. Therefore, the RBI should initiate steps to weaken rupee. It appears that some initiatives are underway as evidenced by the recent rupee depreciation. 

The market reaction to a cut or a hold by the RBI is likely to be muted. The recent market correction is healthy since valuations have been approaching bubble territory. More than the policy response of the RBI, the market will be influenced by economic data for September, particularly corporate sales figures, the trend in exchange rate, exports and capital flows into the market. If the positive trends of August are sustained in September too, the market is likely to respond positively, irrespective of what the RBI does.

V K Vijayakumar, Chief Investment Strategist, Geojit Financial Services 

Disclaimer: Views expressed are personal. They do not reflect the view/s of Business Standard.

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