Monetary policy review: Another rate cut may not help Indian economy

The larger problem here is that government finances are already in a hole; that would be a problem even if the tax cut were the best-designed in history.

Business Standard : It’s almost universally expected in India that the central bank’s monetary policy committee will lower interest rates this week. Many expect it to keep cutting until the policy rate hits 5 per cent by the end of the year; it was 6 per cent in June, and the committee cut it by an unexpected 0.35 percentage points in its last meeting to bring it down to 5.4 per cent. The arguments for a cut are manifold: The Indian economy is clearly spluttering, with growth coming in at a shocking 5 per cent in the last quarter for which data is available; consumer price inflation stands at 3.2 per cent, well below the Reserve Bank of India’s mid-point target of 4 per cent; and industry is loudly complaining that high real rates are depressing investment.

Even the hawkish monetary policy committee, which critics complain has consistently over-estimated inflation in the past, is unlikely to be able to ignore that combination of factors. RBI Governor Shaktikanta Das told the Bloomberg India Economic Forum last month that “there’s room for a rate cut, especially when growth has slowed down.” The bond market has already been given reason to cheer this week, after the government kept its target for borrowing in the second half of the financial year constant, at Rs. 2.7 trillion.

But the RBI would be wise to be cautious. The government in New Delhi won reelection in May by throwing money at the electorate, particularly rural voters. More recently, panicked by the sharp slowdown in growth, it has responded with fiscal measures that are likely to stress its finances, including a big cut in corporate income tax rates last month (though the eventual fiscal stress of that cut might be less than originally feared, given that exemptions are also being phased out).

The larger problem here is that government finances are already in a hole; that would be a problem even if the tax cut were the best-designed in history. The budget India’s finance minister presented to Parliament in July was swiftly undermined when a senior government adviser pointed out that the tax receipts seemed outdated -- and that, in fact, revenues in the last financial year were Rs. 1.7 trillion less than advertised.

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