In its mid-year economic survey, the finance ministry said “tighter” monetary policy meant real interest rates in India were substantially higher than in comparable emerging economies, further clouding the economic outlook.
Faster monetary easing, the ministry argued, would help deleverage corporate balance sheets and restore banks’ profits, helping the economy realise its full potential.
While it retained an official growth forecast of 6.75% to 7.5% for the fiscal year to March 2018, the report highlighted a stronger rupee, deepening farm distress and a disruption in business activity following the launch of a new sales tax, as headwinds.
“There has been an across-the-board deceleration,” said chief economic adviser Arvind Subramanian, the survey’s author. “It is less likely than before that we will reach the upper end of the range.”
Growth slowed to 6.1% in the March quarter, its lowest in more than two years, following monetary reform ordered by Prime Minister Narendra Modi last November to purge high-value banknotes from circulation.
The subsequent launch of a national Goods and Services Tax (GST) has caused chaos on the ground as ambiguous rules have left firms confused on how to price their products.
In a sign of things to come, business surveys showed both services and manufacturing contracting at their fastest rate in years in July, the month that the GST was launched.
Disinflationary pressures allowed the Reserve Bank of India (RBI) last week to cut its main policy rate – the first easing by an Asian central bank this year – by 25 basis points to 6%, the lowest since November 2010. Yet Subramanian, Finance Minister Arun Jaitley’s top economic adviser, said the policy repo rate was still 25-75 basis above the neutral rate.
Although he didn’t fault the RBI’s new inflation-targeting framework, he did question the approach of its Monetary Policy Committee.
“Both expected inflation and GDP are subdued relative to their equilibrium levels,” the survey said. “The conclusion is inescapable that the scope for monetary easing is considerable.”
Even as the RBI resumed cutting rates, it warned inflation could accelerate to as high as 4.5% in October-December. The economic survey, however, took the view that India’s inflation, which cooled to a record low of 1.54% in June, is undergoing a “structural shift”.
It expects headline inflation to remain below the RBI’s medium-term target of 4% through to the end of March 2018 on the back of normal summer rains and the deflationary impact of farm loan waivers.
Four Indian states including Uttar Pradesh, which has a population bigger than Brazil’s, have agreed to waive billions of dollars in farm loans to offer relief to farmers reeling from losses caused by bad weather.
Subramanian said the loan waivers were likely to be deflationary as the states would have to either raise taxes or cut spending to keep their budget deficits in check.
