It?s hard to buy the argument that growth will bounce back if the Reserve Bank of India (RBI) cuts policy rates. To begin with, growth hasn?t collapsed, it has merely moderated, perhaps more sharply than anyone had envisaged. Investment, however, has collapsed and the blame for that lies squarely with the Union government, which has been unable to resolve supply side bottlenecks ? steel plants, for instance, are starved for iron ore. Companies are unwilling to move ahead on projects because they?re unsure of policies, whether on land acquisition or on environment. Indeed, as a survey by Crisil shows, corporates are least bothered about interest rates, it?s the lack of clarity on policy that?s keeping them from adding more capacity.
To cite an example, unless the government decides quickly how coal should be priced, no power plants will come up; the sequential drop in BHEL?s order book for the three months to June, 2012, to R1.33 lakh crore, is evidence of how sluggish investments are right now. In short, even if interest rates are down 100 basis points, it?s unlikely companies would be able to go ahead with their projects.
The RBI has all along argued that for growth to sustain, inflation needs to be benign. The rise in prices unfortunately continues to be sticky. The June PMI data showed that input prices are at a nine-month high, while output prices are at their highest levels since 2005.
True, headline inflation in June came in a shade below expectations at 7.3% and lower than May?s 7.6% and April?s 7.5%. Moreover, core inflation ? or manufactured non-food product inflation ? closely tracked by the RBI, came in at a steady 4.9% compared with levels of 8% a year ago.
However, the lower inflation in June was the result of a smaller rise in the prices of fuel ? up 10.3% compared with 12.8% in March. However, prices of pulses and other proteins continued to rise, signalling that food inflation hasn?t been tamed.
Also, while the new combined CPI for June came in at 10%, lower than May?s 10.4%, it nonetheless stayed in double digits. Excluding food and fuel, the CPI clocked 9.1%, the lowest in the last six months, but that could change quickly because, going by current reports, the crop this season could fall short of the country?s needs unless there?s more rain soon.
Among the crops that could be in short supply are coarse cereals, pulses and oilseeds. A lower output of foodgrains, together with a higher minimum support price, which was upped 15% last month, means food could become more expensive, in turn driving up inflation.
As for fuel prices, the RBI has been exhorting the government to increase diesel prices so as to ease the pressure on the fiscal deficit; the central bank has argued that although there could well might be an immediate impact on inflation, the blow might not be as hard because pricing power is low.
Between April and June this year, total under-recoveries on account of regulated fuels ? diesel, kerosene and LPG ? have totalled R47,811 crore. The government has budgeted for R46,300 crore of fuel subsidies this year and there are last year?s arrears to be paid off.
In short, there are few signs that inflation could come off given that crude oil prices too are back at levels of $104 per barrel. The government hasn?t moved on diesel prices yet, but continues to pressure the central bank to cut rates. Until it does, the repo should remain at 8%.
