Indian central bank in focus again

Mumbai: After the prime minister belied expectations and triggered a stocks slide last week, the spotlight will shift to the central bank, which is set to announce its mid-quarter monetary policy on Tuesday against a backdrop of slowing growth and an uncharacteristically weak monsoon.

Central banks from Australia to South Korea and Europe have cut interest rates to lift their sagging economies, while other countries such as Japan and the US have stepped up spending to beat a downturn.

The Reserve Bank of India (RBI), however, has been a rare exception that has stuck with a hawkish stance although it lowered rates in April for the first time in three years.

The RBI, which believes monetary tinkering is not the prescription to deal with the gloom hanging over the nearly $2 trillion economy, is unlikely to stray from its stated policy. It is more concerned with price pressures that are bursting at the seams, especially for food items that are driven by supply-side bottlenecks. Fuel prices, kept artificially low by unsustainable government subsidies, are another time-bomb the RBI is worried about.

“The government and the RBI are caught in the horns of a dilemma,”

said one fund manager at a foreign financial institution with significant exposure to Indian equities. “Growth has been on a slowing trajectory for many months, and the policy drift is causing irreparable harm to an economy with tremendous potential.”

Prime Minister Manmohan Singh, an economist who understands the problems hobbling growth, lacks the leadership skills needed to tackle the issues headlong. For instance, unless prices are increased of heavily subsidised fuels like diesel and cooking gas, there is no way of meeting the government’s fiscal deficit target of 5.1 per cent of GDP, or about $91.5 billion, for 2012-13.

In just the first four months of the financial year that began on April 1, the government has spent most of the $7.6 billion earmarked for fuel subsidies for the full year. As India depends on imports for about 80 per cent of the annual fuel consumption, the country faces a serious challenge because it would worsen a widening current account deficit.

Singh had raised expectations of kickstarting stalled reforms like opening up the supermarket sector to global giants after he took charge of the finance ministry in late June and talked about reviving the ‘animal spirits’ in the economy. So, it was a huge let down when nothing was forthcoming even after the presidential election got over.

Any reforms are now unlikely until September after the end of month-long monsoon session of parliament that begins on August 8.

Little surprise the top-Sensex skidded 1.9 per cent last week — the biggest weekly loss since early April — as foreign institutional investors led the ranks of sellers. The fall would have been much more but for a 1.2 per cent rebound on Friday, powered by private-sector ICICI Bank after the country’s second-largest lender posted a forecast-beating 36 per cent jump in quarterly earnings.

However, state-controlled banks that have exposure to ailing industrial sectors are staring at heavy provisioning. Shares in Punjab National Bank and Union Bank fell sharply on Friday after they reported a sharp rise in provisions for bad debts.

There could be bigger shocks over the near-term as drought-like conditions threaten many parts of the country. An empowered group of ministers on drought is expected to meet this week for the first time since 2009, when the rains were the poorest in nearly four decades.

The monsoon, which is the main source of irrigation in India, so far this year is about 22 per cent below average. It has affected sowing of many crops, especially of pulses and oilseeds, and would pile pressure on food price inflation that is running already above 10 per cent.

Still, some market participants are betting for a rate cut on Tuesday.

“While our house view remains that there will be no rate cut, our trading bets will be for a 25 basis points repo rate cut,” Ramit Bhasin, head of markets for India & South East Asia at Royal Bank of Scotland, told reporters.

Given the weakness in the economy and easing core inflation, which excludes food and fuel prices, Siddhartha Sanyal, chief India economist at Barclays Capital, also is biased towards a quarter-point cut.

“Markedly sub-par growth, softening core inflationary pressures, near-zero fiscal spending headroom, and what are likely be only hesitant government policy initiatives to revive the economy underscore the need for greater monetary accommodation in coming months,” he wrote in a newspaper article.

He expects a 100 basis points rate cut in the remaining months of 2012-13, including in July.

— The writer is a journalist based in India,