Riding a bicycle is not only good for health but contributes to reducing pollution as well. But if you expect to cover 2,000 miles on a bicycle in a short span of time; you might be asking too much of your body. Similarly, lower interest rates contribute to higher economic growth, but if your key objective to revive tanking growth is by slashing borrowing rates, it would be an unrealistic expectation.
Economic growth is a function caused by a number of factors that include lower inflation, higher employment, lower interest rates, easy credit facilities, and ease of doing business among others. At present, too much of attention is being given to the monetary policy from the view point of turbocharging economic growth. The industry has been demanding policy rate cuts, suggesting this will contribute to higher profits. Lackluster corporate performance has been a cause of a concern for the Government. As reported by the Business Standard, the average growth in revenues of 4,033 companies fell by 1.62%, while the net profit dropped by 10.5% in the quarter of December 31, 2015.
In the pre-budget time, the demand for rate cuts had waned as there were many speculations on the budget. Many experts were predicting that the Government might miss the fiscal deficit target. RBI maintained a status quo after slashing policy rates by 50 bps in September 2015. Factors that led RBI to hold rates unchanged include:
Budget 2016-17—the game changer
The Budget 2016-17 was a big relief. The Government not only reiterated its commitment to adhering to the target of 3.9% of fiscal deficit for the Financial Year (FY) 2015-16, but set a steep target of 3.5% for FY 2016-17 as well. This was indicative of
the Government’s continued commitment to maintaining fiscal discipline and rationalising its spending. On this backdrop, the discussion of the RBI announcing another round of rate cut has gathered momentum post budget.
Let’s see what are the other factors that have lifted the rate cut hopes:
The Government has announced its intent to assign Rs 25,000 crore to aid Public Sector Banks (PSBs). The RBI was hopeful that the Government would take the right steps to recapitalize banks. PSBs have been reeling under pressure due to their bad asset quality. Non-Performing Assets (NPAs) have been piling up putting strain on the capital of banks reducing their loss absorption capacity. Although Rs 25,000 may be a drop in the ocean, given the severity of the problem, it’s a substantial amount to showcase clarity on the Government’s stance.
The RBI had raised its concerns on the high inflation in the services sector such as education, healthcare, and housing among others. The Budget announced a number of steps to address these concerns. Exemption in service tax for smaller houses (less than 60 Sq.m), additional exemptions on housing loans for first time buyers, higher exemptions on House Rent Allowance (HRA), and initiatives to digitalizing land records are expected to provide some relief.
Similarly, to make healthcare more affordable the Government has added about 200 formulations to the price control list, taking the total to 800. Further, the Government announced that it will open around 3,000 generic medical stores across the country. Generic drugs are cheaper than the branded ones, and are considered to be equally effective. National Dialysis Programme is expected to provide benefits to many needy patients. The Government has also planned to provide health insurance worth Rs 1 lakh per family under a new health protection scheme.
To address the problem of inflation in the higher education sector, the Government announced its intent to set up Higher Education Funding Agency (HEFA) with an initial capital of Rs 1,000 crore. Although this alone may not be enough to tackle the problem of the escalating cost of higher education, it may provide foundation to further initiatives.
The poor state of rural economy, falling agricultural output, and dwindling of farmer’s income have also been affecting economic growth. The Government has provided higher budgetary support to pro-farmer schemes. It has allocated more money to improving irrigation facilities and has prepared a plan to bring down distress of farmers by launching comprehensive crop insurance schemes. It has been observed that abrupt rises in the price of a few food articles led to higher consumer inflation. The Government has been planning to increase Minimum Support Prices (MSPs) for sensitive commodities such as pulses.
Addressing all concerns of the RBI, the demand for rate cut has resurfaced.
Some more reasons why Personal FN and the experts are expecting the RBI to cut rates
Inflation continues to fall and industrial growth remains under pressure.
Inflation measured by the movement of Consumer Price Index (CPI) came in at 5.18% in February 2016. The food inflation has fallen to 5.30%. In January 2016, the retail inflation stood at 5.69%, while the food price inflation hovered at 6.85%. On the other hand,
industrial growth brewed in the negative for the third consecutive month in January 2016. Manufacturing sectors collectively recorded a drop in growth of 2.8%, that dragged the overall performance of the Index of Industrial production (IIP). IIP fell by 1.5% in January. Reserve Bank of India (RBI) has been aiming to achieve 5.0% inflation target by March 2017.
Falling Inflation And Falling Industrial Growth
(Source: MOSPI, PersonalFN Research)
Oil Prices continue to remain weak
Even after recovering sharply from their bottoms, oil prices remain weak internationally. Weaker oil prices help India save valuable foreign exchange as imports are lower. The Government has been discouraging gold imports by pushing down the demand for physical gold. It has been encouraging people to invest in Sovereign Gold Bonds by offering some additional tax incentives. All these factors would eventually help Indian control Current Account Deficit (CAD), providing strength to Rupee. The Prime Minister has already clarified that India is not interested in joining the currency devaluation race.
The RBI seems to be contained with the Budget 2016-17
The Commitment of the Government to sticking to 3.5% target of fiscal deficit in FY 2016-17 seems to have gone down well with the RBI. The RBI has perceived this as the firm intent of the Government on fiscal consolidation.
Clearly, all indicators point at a possible rate cut in coming days. The first bi-monthly monetary policy statement for 2016-17 is scheduled to be announced on April 5, 2016. However, before you conclude that, RBI will definitely cut rates; please don’t forget to read the telling quotes of the RBI Governor that reads as,
“The headline number of 3.5 per cent fiscal deficit target is a firm indication of government’s intent to fiscal consolidation. Both the markets and RBI are comforted by that. How that feeds into monetary policy is you have to wait and watch”.
Let’s not take the RBI for granted. It has a long history of surprising the markets by its common-sense actions.
Speculation is bad for your investment portfolio. Continue to invest keeping in mind your financial goals and risk appetite.
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