Growth not my baby, says the RBI
So, if the RBI feels it is helpless to do anything much to boost growth, can nothing be done?
It is not that the RBI does not know that things are bad. The Monetary Policy Report analyses the global economy and the domestic data to conclude that this year’s growth is likely to be just 6.1%, rather than 6.9% that had been (fondly) hoped for just two months back. But the reality is that there has been surplus liquidity in the system in August and September. The weighted average rate in the call money market has been below the repo rate for most of the first six months of the current fiscal year, which is the clearest signal that liquidity is adequate and is no constraint on economic activity. Transmission of past rate cuts to the lending rates of banks has been tardy. While the repo rate has been cut by 110 basis points, but the weighted average lending rates of commercial banks declined by just 29 basis points.
As people in the market know, banks do not want to lend, unless the borrower has ironclad collateral and the banker who makes the loan can satisfy a roving Vigilance Commission/Enforcement Directorate/CBI official, who happens to take in interest in the why and whereof of the transaction, 300% that the loan represented no risk whatsoever to the bank. This rules out most business loans.
So, if the RBI feels it is helpless to do anything much to boost growth, can nothing be done? “With inflation expected to remain below target in the remaining period of 2019-20 and Q1:2020-21, there is policy space to address these growth concerns by reinvigorating domestic demand within the flexible inflation targeting mandate. It is in this context that the MPC decided to continue with an accommodative stance as long as it is necessary to revive growth, while ensuring that inflation remains within the target.” What do these sage lines from the Monetary Policy Statement mean?
There is scope for policy action to reinvigorate demand, but the RBI’s policy is confined to making liquidity available when the demand for liquidity goes up. So, its stance will be accommodative. Who, then, has to take the policy action that the MPC says is possible? Clearly, the government.
The RBI has tossed the ball firmly into the government’s court. The government has already taken some substantial action by way corporate tax rate cuts. While the general rate cut has been to bring the effective tax rate (total corporate tax collected as a proportion of the total pre-tax profits of all companies on which tax is levied) nearly five percentage points down, the new effective tax rate of 25.17% remains two percentage points above the effective tax rate in 2013-14. But the tax cut for new manufacturing companies is real and significant. The effective rate of 17.01% brings it on par with Singapore’s and lower than the nominal rate in most Asian economies.
Will companies incorporate new subsidiaries and set up new manufacturing facilities, to take advantage of the 17% tax rate? The natural instinct of the Indian promoter would be to set up a fresh subsidiary and transfer existing assets to the new unit and try to claim tax benefits for ongoing operations. Suppose the taxman stops this subversion of the goal of promoting new investment. Will industry set up new capacity? Eventually, yes. But the RBI’s survey shows that capacity utilisation, seasonally adjusted, is just a tad over 74%. Unless there are firm signs of short-term growth, why would any promoter rush in where Masayoshi WeWork Son would fear to tread, and add to capacity that would be utilised only later?
If new entrepreneurs can be found, who think they can displace some old existing fogeys with superior technology and greater efficiency, they would set up new capacity. That would boost investment. But such entrepreneurs are rare, particularly in the manufacturing space, where the Indian penchant has been to import components cheap, lobby the government for steep protection on the finished product, turn a few screws here, solder a few wires there and stick a few labels on shiny packaging and cry Make in India!
Perhaps foreign manufacturers can be induced to set up manufacturing in India. After all, India has raced up the World Bank’s Ease of Doing Business rankings and it is now relatively easy to get an electricity connection in Delhi or Mumbai. But then, there stand in the way India’s reputation for changing rules mid-course, and gratuitous ingratitude, as in the shoddy treatment of Cairn, whose discovery of oil in Rajasthan has saved India billions of dollars worth of foreign exchange and was slapped, for its pains, with a retrospective tax on consolidation of its own subsidiaries with no change in beneficial ownership, on which no capital gains tax would be discernible to anyone with any sense of the first principles of taxation.
Still some company seeking to flee China’s increasingly high-wage economy could see India as an ideal location for setting up shop. Such targets should be identified and incentivised. But these are iffy sources of fresh investment.
The only sure way to step up investment is for the Centre to step up its own investment activity and give the states additional leeway to step up their investment activity. Of total government spending in India, the Centre today accounts for about 42%, the bulk of the spending is by the states. Squeezing the States’ finances is guaranteed to depress investment. The opposite is true, too.
Let the National Infrastructure Investment Fund tap global capital markets, where over $17 trillion worth of bonds carry negative rates of interest, and raise funds to be channelled to state government-owned infrastructure development corporations, with appropriate guarantees by the concerned state governments, to carry out infrastructure projects. Build a new town each, say. Or an airport. India is deficient in both towns and airports when seen against the urban population and the demand for air travel that will materialise a decade hence.
Pouring state funded concrete is the immediate solution to decelerating growth. That, after all, is not the RBI’s job.
However, the RBI has to work hard, along with Sebi and the government, to create a viable market for corporate bonds, so that the mediation of liquidity to investment projects can take place efficiently. The banks must be recapitalised and bankers’ seats shifted from under the Damocles’ sword of criminal suspicion of any banking decision.