Indian macro-economic fundamentals continue to record an improvement in spite of the uncertain global economic outlook. A modest recovery in economic activity is underway, retail inflation has eased, the magnitude of the current account deficit is protected by falling commodity prices and the quality of the fiscal deficit appears growth-positive. However, there are still some concerns and the impact of the anticipated rate cut this week may only have a muted impact.

Falling inflation The halving of CPI inflation to 3.6 per cent in August 2015 from 7 per cent in August 2014 has quelled fears related to the potency of the considerable monsoon deficit in 2015. Early estimates of firm kharif foodgrain and oilseed output, modestly improved prospects for the upcoming rabi season, following the recent spell of rainfall, and impending imports of pulses and onions are expected to contain food inflation in the near term. Moreover, the likelihood of continued softness in crude oil would suppress the risks arising from a weaker rupee. Lower commodity prices also continue to buffer India’s current account deficit.

CPI inflation is likely to undershoot the central bank’s projection of 6 per cent for January 2016 by a considerable margin. Accordingly, there appears to be sufficient room for a 25 bps reduction in the repo rate in the upcoming policy review, which would be the fourth cut in the current year. Anaemic transmission to bank lending rates is also expected to improve appreciably in the coming quarter. The positive impact of enhanced transmission would exceed that of the anticipated 25 bps rate cut. With mixed progress on steps to unclog supply side bottlenecks, which are critical to sustaining lower inflation levels, the space for subsequent easing may be limited.

Speedier clearances, easing of approvals, front-loading of Government spending, policy changes in sectors like roads and some improvement in the availability and cost of non-bank credit have contributed to pockets of recovery.

While a rise in spending in April-July 2015 has widened Government of India’s fiscal deficit above the year-ago levels, it is expected to boost economic growth. The impact of a weaker rupee on fiscal metrics is far more muted than in the past, following the reduction in fuel subsidy. Moreover, healthy inflows from indirect taxes and disinvestment have diminished the likelihood of extensive fiscal tightening toward the end of the year.

Some concerns While urban consumption demand may pick-up, the improvement in the rural segment may be subdued in the near term. This, along with the overcapacity in several sectors, has constrained the recovery in non-infrastructure capex. The sluggishness in the residential real estate sector is also holding back a widespread recovery in the construction sector.

High levels of debt of large corporate groups, persisting stress in some highly capital intensive sectors such as power and steel and the lack of any appreciable improvement in the financial positions of power distribution utilities in various States are other concerns. Stressed sectors such as iron and steel, power and sugar accounted for around 15 per cent of banks’ total domestic credit book at end-June 2015, highlighting the extent of the concern at a systemic level.

While a repo rate cut in the upcoming policy is certainly justified by the receding inflation risks, its effectiveness in spurring a wider pickup in economic activity is likely to be muted. Moreover, sustained growth in government capital spending and an improvement in the pace of Central and State level reforms, remain more critical to revive the economy than another small dose of monetary easing.

The writer is MD & Group CEO, ICRA 

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