Monetary Policy Review: Amid Inflation Woes RBI Must Push Banks To Lend More To Stimulate Growth

The economy should be prepared for further interest rate increase due to external sector dynamics and the building up of inflationary pressures. The pace of revival of domestic economy too is tardy. In the ensuing third bi-monthly policy review of Reserve Bank of India (RBI) slated for 1 August 2018, there could be further increase in repo rates. Experts put the likely hike at 25 basis points that can take repo rate up to 6.5 per cent. The headwinds of inflationary pressure are mounting with wholesale price inflation reaching a five-month high to 5.77 per cent in June 2018 up from 4.43 per cent in May 2018 sharper than expected. Within Wholesale Price Index (WPI), continuing jump in fuel prices due to a surge in international crude oil prices and uptick in food inflation has been impacting inflation for the last five months in succession. It is threatening to elevate inflation further.

Trends Of Headline Inflation

The retail inflation led by Consumer Price Index (CPI) too has risen to 5 per cent in June 2018, up from 4.87 per cent recorded in May 2018, causing anxiety about its impending impact on the economy. As against such development, RBI projected CPI inflation to stay range bound between 4.8 per cent to 4.9 per cent in the first half (H1) and 4.7 per cent in the second half (H2) of financial year 2019 (FY19) in its last bimonthly monetary policy review, including the house rent allowances (HRA) impact for central government employees as per Seventh Pay Commission revision. It is projected to reach 4.6 per cent in H1 and 4.7 per cent in H2 excluding impact of rise in house rent allowances during the fiscal. But the present headline inflation has breached all estimates primarily due to a surge in crude oil prices. Since RBI is well committed to contain inflation within the glide path of +/- 2 per cent over 4 per cent, it has a challenge to maintain retail inflation trajectory within the target unless supply side dynamics synchronise.

Impact On The Economy

In the backdrop of rising inflation, the cost of inputs for trade and industry will rise, pushing down productivity. Hence, the revival of the industrial growth has been subdued. As against the market expectations of 5.2 per cent growth year-on-year (YOY), the Index of Industrial Production (IIP) has slipped to 3.2 per cent in May 2018 as against 4.8 per cent recorded in April 2018. It is mainly due to sluggish performance in manufacturing and power sectors, and poor off take of fast moving consumer goods. However, IIP was 2.9 per cent in May 2017, showing only a slight improvement over the year. In sub-sectors, the low growth of power sector at 4.2 per cent as against 8.3 per cent a year ago has caused the slide.

Similarly, the Nikkei India Manufacturing Purchasing Managers Index (PMI) too rose to 53.1 per cent in June 2018, compared to 51.2 per cent in May 2018 showing only feeble signs of revival. The growth seems to be gasping for breath to revive and pick up pace.

Moreover, the revisions in the minimum support price (MSP) to 150 per cent of cost of cultivation on 14 major crops will impact in many ways. It can shoot up prices of agriculture produce that can raise inflation by 30 to 110 basis points and can widen fiscal deficit. As against the forecast of even spread of monsoon by the Indian Metrological Department (IMD), the uneven rainfall has led to 8 per cent deficit across geographies. The rainfall deficiencies have stretched to -20 to -59 per cent in 12 meteorological districts in northern and eastern rice growing regions. The progress of monsoon and sowing pattern is to be keenly watched to perceive the future potentiality.

Flow Of Bank Credit

In the revival of economy, the role of bank credit for mass of entrepreneurs at the bottom of the pyramid is critical – more so when they cannot access funds from alternate sources. But the collateral damage of recent spate of high non-performing assets (NPAs) in banks has doused the risk appetite more significantly in public sector banks (PSBs) that have greater reach to hinterland. Credit growth in banks is 10.9 per cent YOY – 26 May 2017 to 26 May 2018. Out of which, the credit growth in PSBs remained subdued. RBI data for FY18 shows that the credit growth of PSBs was at 4.7 per cent as against 20.9 per cent in private banks.

In terms of sectoral growth, agriculture stood at 6.4 per cent, industry 1.4 per cent, while services sector taking the major chunk of growth at 21.9 per cent. Retail loans grew by 18.6 per cent, showing a clear sign that flow of credit to agriculture and industry has gone down with its debilitating impact on growth.

Even in a rising interest rate scenario, it is absolutely essential to restore credit deployment appetite of PSBs, stopping the collateral damage done by bad loans so far. NPA problem cannot be solved quickly but depriving enterprise of credit can mar the prospects of growth. RBI may raise the interest rates to adjust with the liquidity pattern to stem inflation.

Moreover, with decision to drop the controversial Financial Resolution and Deposit Insurance Bill 2017 due to widespread outcry on its ‘bail in’ clause, the deposit growth in banks may increase now, pushing up resources. Since India is presently navigating an upward interest rate curve in tandem with many global central banks, the trade, commerce and industry will have to readjust its working to support economic growth to harness its full potentiality. Realising the fact that NPA resolution is a long drawn process, RBI has to reinforce in its monetary policy reviews the importance of bank lending to stimulate growth.