Reality Check for India's Central Bank as Slowdown Deepens

  • Governor Patel’s hopes for a ‘V-shaped’ recovery now dashed
  • Cuts to fuel levy indicate government is ‘blinking’: analyst

Inside the RBI's Growth and Inflation Dilemma

India’s central bank has finally accepted the inevitable -- growth in the $2 trillion economy is slowing more than it expected.

It means recovery from an unprecedented cash ban imposed late last year by Prime Minister Narendra Modi will be a long, drawn out one and not the V-shaped bounce Governor Urjit Patel had hoped for.

With growth estimated to slow to a four-year low, the door’s open for more easing by the Reserve Bank of India in coming months as pressure builds on it to provide a boost to the economy that has been roiled by a chaotic roll out of the goods and services tax and the after-effects of the cash ban.

Of course, the downgrade to growth by the central bank risks hurting inflows from foreign investors, many of whom have been pulling money out of high-yielding Indian assets in recent weeks.

"The implementation of the goods and services tax so far also appears to have had an adverse impact, rendering prospects for the manufacturing sector uncertain in the short term," the central bank said in a statement released Wednesday. "This may further delay the revival of investment activity."

Earlier, the RBI kept the benchmark rate at a seven-year low of 6 percent and painted a rather subdued picture of the economy. It cut its growth forecasts following a slew of downgrades by investment banks and private sector economists.

It seems the RBI is not confident on growth at a time when inflation is reflecting cost-push pressures, said Rupa Rege Nitsure, chief economist at Mumbai-based L&T Finance Holdings Ltd. "It has kept alive the hope that RBI will cut rates to push growth." 

Slowing Growth

In a February interview with the CNBC Television18 Network, Patel was confident that India will bounce back quickly from the cash ban.

"Almost everyone agrees that the impact is going to be a sharp ‘V,’ that we would have a downgrade of growth for a short period of time," Patel said on Feb 17.

Modi, late on Wednesday, said growth will improve in coming quarters and his government’s economic measures are taking India on the path of development. "There are some people who sleep well only after they spread a feeling of pessimism all around," Modi said in a speech in New Delhi after two key allies criticized the administration’s economic management. "We need to recognize such people."

Far from it. Growth in India has been slowing for the past five quarters and a Bloomberg survey published last week forecast India’s GDP will grow at 6.8 percent in the financial year through March 2018. The RBI cut its forecast for gross value added -- a key input of GDP -- to 6.7 percent from 7.3 percent.

The slowdown appears entrenched. India’s banking system is busy tackling bad loan problems, while companies are refusing to invest more as they try to lower debt taken during the boom years.

Other surveys released this week showed:

  • Consumer confidence worsened in September from the June survey, as more people worried about employment, prices and incomes (RBI survey)
  • More households expect inflation to accelerate over the coming quarter as well as over the coming year, across different products (RBI survey)
  • External forecasters predict GVA will grow 6.6 percent this financial year, slower than the RBI’s economists project; consumption and investment are both expected to fall over the same period (RBI survey)
  • Business sentiment in the manufacturing sector worsened April-June, though respondents were more optimistic for the subsequent quarters (RBI survey)
  • Capacity utilization fell to 71 percent April-June from 74 percent the previous quarter, meaning slack at factories has increased (RBI survey)
  • Nikkei India Composite PMI reading in September indicated growth for the first time in three months as services and manufacturing recovered from GST-related contractions; expansion in new orders "was only slight and weaker than the long-run trend"

The slowdown leaves the onus on the government to provide a boost to investment by raising spending. But the room for that is limited.

Sluggish output means revenue collections haven’t kept pace and any spending boost would only widen one of Asia’s largest budget deficits, stoke inflation and, possibly, prompt a review of India’s investment grade rating. Standard and Poor’s cut China’s rating last month citing risks from soaring debt.

Add to that the central bank has halved its annual payout, asset sale proceeds are far from the target, and telecom spectrum auctions may not find many takers as carriers struggle amid a brutal price war. Refund claims under the goods and services tax have further put the receipts goal at risk.

Fiscal Slippage

With the RBI on the sidelines for now, pressure will increase on New Delhi to provide a much needed stimulus to the economy.

Analysts at Nomura Holdings Inc. forecast a 55 percent probability that India will not be able to stick to its fiscal deficit target of 3.2 percent of gross domestic product this fiscal year and they expect news on slippage to be announced by mid-December.

There are already signs that the government is blinking. Hours before the RBI’s decision, the government cut a domestic levy on gasoline and diesel, which analysts like Mahesh Nandurkar at CLSA India Pvt. Ltd. say will impact government revenues and raises concerns about public finances.

"It highlights the government’s political compulsions," he wrote in an Oct. 4 report. "This revenue reduction in addition to uncertainties on GST collections, which appear to running short at the moment, raises fiscal concerns."

— With assistance by Archana Chaudhary, and Sunil Jagtiani

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