Last Updated:
Today, the lack of industrial credit growth is not because the cost of funds is high but because of the lack of adequate topline growth in businesses or because of availability of other sources of funds, writes SBI Mutual Fund Chief Economist.
Market analysts are now speculating about possible rate reductions by RBI in December or February, although this enthusiasm has been tempered by two subsequent developments.
In its recent monetary policy meeting in October 2024, the Reserve Bank of India (RBI) decided to keep the policy rate unchanged at 6.5 per cent, while shifting its stance from the ‘withdrawal of accommodation’ to the ‘neutral’ position. This change marks a notable shift after two and a half years and is seen as a signal that the RBI is opening the door to potential rate cuts in the near future. Market analysts are now speculating about possible rate reductions in December or February, although this enthusiasm has been tempered by two subsequent developments.
First was the release of September CPI. Second was Governor Das’s hawkish remarks at Bloomberg’s India credit forum citing “rate cuts at this stage would be premature and risky”. The RBI is data-dependent and the change of facts could change the opinion. Hence, delving a bit deeper into the recent growth-inflation trends warrants merit.
Underlying inflation trends are benign
One of the key factors influencing the RBI’s stance is the recent inflation data. The Consumer Price Index (CPI) for September registered at 5.5 per cent, surpassing the expected 5.1-5.2 per cent.
That said, analysing recent inflation trends reveals a more benign outlook. Retail inflation averaged 4.6% in the first half of FY25. A higher than 4 per cent RBI’s target was primarily driven by vegetable prices, which have a 6 per cent weight in the CPI basket. Excluding this volatile category, inflation drops to 3.5 per cent. Moreover, core CPI has been consistently around 3.4 per cent. Finally, a significant portion of the CPI basket (50-60 per cent) reports inflation below 4 per cent, throughout 2024. This suggests a lack of significant price pressure across most sectors of the economy, indicating that monetary policy does not necessarily need to be restrictive (real rates: Repo rate less CPI inflation has been >1%).
It may not be practically desirable to target 4 per cent CPI inflation in India, unless:
Food and beverages account for a substantial 46 per cent of the CPI, with fuel and core goods and services making up 7 per cent and 47 per cent, respectively. Historically, CPI inflation has averaged around 5.1 per cent in the last five years and 5.7 per cent in 10 years. Fuel and core CPI had centered around 5 per cent for most time periods. Most years of higher inflation had primarily been due to surge in food prices.
According to the 2015-16 Agriculture Census, 86.1 per cent of farmers in India are small and marginal, meaning they have less than two hectares of land and they own nearly half the crop area. The agriculture sector is not dominated by big entrepreneurs but rather small farmers who are in agriculture as a profession because that is all they know. They lack the economies of scale and continue to face rising costs of fertilizer, pesticides (3 per cent CAGR in 5 years), labour (around 5 per cent rise per annum) and transportation, making it difficult to sustain on just about 7 per cent accretion in their topline (a heuristic assumption of 3 per cent volume growth and 4 per cent price growth).
To add, 40 per cent of the Indian labour force is deployed in agriculture. Against such a backdrop, desiring 4 per cent food inflation on a sustained basis when corporate wages are growing at 10-20 per cent per annum may not be socially acceptable, unless u see massive productivity gains in the sector. With the MSP hike averaging around 5.5 per cent in the past 10 years (weighted by CPI), getting the food inflation sustainably under 4 per cent would be a tall task.
Either of three things need to happen. We see massive productivity gains in agriculture. Or we see the rebasing of the CPI series (long due) which one could logically suspect to be assigning lower weights and hence vulnerability to food. Or we see reduced labour absorption in the farm sector (another way to improve productivity).
Growth still needs a policy support in India, credit cycle has just started
Despite the positive inflation indicators, questions remain about the necessity of a restrictive monetary policy. The private sector is beginning to show signs of recovery, with consumption demand normalizing from pre-COVID levels. However, the Government still plays a crucial role in stimulating growth. Growth still needs a policy support in India if it were to reach its full potential especially given the global backdrop of languishing growth and trade war or geopolitical aspects playing deep role in shaping trade and exports demand.
Rate cut could come by, but it would be symbolic
The Q2 FY25 GDP print would be critical to shape the monetary policy discourse. We suspect that the growth would underwhelm RBI’s expectation, perhaps driving a reassessment of growth inflation conundrum in India by the MPC members. Given that peak policy rate in the current hiking cycle had been significantly below the previous peaks, one anyways expect a very shallow rate cutting cycle this time around. We suspect February or April policies are more likely time periods for a discussion on rate cuts.
Rate cuts aren’t an ideal answer to India’s macro situation
Bank credit has moderated from nearly 16-17 per cent in FY24 (adjusted for HDFC merger) to 13 per cent now and there is a struggle for deposits. While the market seems squared on the next repo rate action, a move to easy the banking system liquidity, either by CRR cut or any other macro prudential action, is the greater need of the hour to address India specific macro dynamics.
Interest rate works its way to growth via cost of funds channel. But today, the lack of industrial credit growth is not because the cost of funds is high but because of the lack of adequate topline growth in businesses or because of availability of other sources of funds — equity issuances being a case in point. That said, industrial credit offtake is picking in India.
As industrial credit off-take begins to pick up, the RBI may need to consider other measures to ensure adequate liquidity within the banking system, rather than relying solely on interest rate adjustments. We would reiterate that India’s growth is at a nascent stage of recovery and still needs policy support especially when the government needs to consolidate.
(The author is the chief economist, SBI Mutual Fund)
