Opinion Cut to the chase

It says a lot about the state of the economy and business sentiment that the Sensex fell by 661 points on a day when the RBI cut its overnight lending rate by 25 basis points (bps) to 7.25 per cent. The reason the markets tanked was probably not so much that the rate cut announced was half of what was widely wished for but because of the diminished likelihood of further cuts. The RBI indicated as much by projecting CPI inflation to rise to 6 per cent by January 2016, higher than its April policy forecast of 5.8 per cent for end-March. That, in turn, was based on the possibility of a second consecutive monsoon failure, reinforced by the met department’s downgrade of its forecast for rainfall during this season to “deficient” from the earlier “below normal” prognosis. Upside risks to inflation, via increased food prices, reduce the room for rate cuts down the line.

In fact, the RBI’s latest monetary policy review is notable for effecting a 25 bps repo rate cut despite the prospect of a bad monsoon and the recent firming up of global oil prices. This may indicate that it is not too convinced by the government’s recent data pointing to a significant pick-up in GDP growth and investment. The RBI has actually marked down its output growth projection for 2015-16 from 7.8 to 7.6 per cent “with a downward bias”. Contrary to statements from the government of an industrial revival underway and growth rates being poised to touch double-digits, the RBI has referred to “low domestic capacity utilisation, still mixed indicators of recovery, and subdued investment and credit growth”, which makes “a case for a cut in the policy rate today”. In other words, it appears convinced of the necessity for monetary easing now — which is a good thing — and only uncertainty over the monsoon may have come in the way of a deeper rate cut.

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The ball is clearly now in the government’s court. Contingency plans to deal with a poor monsoon — whether by way of timely release of food stocks and contracting imports of essential commodities to quell speculative pressures, ensuring adequate supply of seeds and fertilisers to farmers, and keeping a lid on minimum support price increases — must be prepared for implementation in close coordination with the states. Equally, it would do well not to be carried away by the recent GDP growth estimates based on a revised methodology that neither the markets nor probably the RBI find credible. Make no mistake, weak corporate earnings and no major greenfield projects taking off are the clearest signs of an economy that is not quite out of the woods.