On September 4, 2013, a regular RBI press conference to introduce the new governor of the central bank may have just become a footnote to history were it not for audacity of the entrant. The rupee was in a free fall, stock markets were faltering and foreign investor confidence in India was at an all time low. India was dubbed part of the `Fragile Five’ with poor macros, a weak currency, a yawning current account deficit and a plummeting stock market.
In a matter of minutes, Rajan had turned things around. An three-year FCNR deposit scheme with currency protection for banks, a clear roadmap to achieve inflation targeting along with a monetary policy framework and a strong message in favour of savers and against crony capitalists set the stage for the real big bang reforms from the central bank. While stock markets celebrated and bond traders gave high-fives, the real impact was on the forex market. In the last half-an-hour of trade after Rajan’s press conference, the rupee surged from all-time lows to end the day stronger. As investors digested what Rajan was trying to do and it became increasingly clear that the governor was aiming at fundamental transformation, the outlook for the currency changed overnight. Much of the world’s currencies has struggled against the dollar in the past few months but not the rupee. It has fallen against the dollar no doubt but is up against all the major world currencies. The credit for much of this transformation must go to Rajan. His vice-like grip on interest rates his refusal to buckle under pressure from corporate lobbyists and a government worried over economic growth was enough to convince foreign investors that the governor was his own man and would not play to the gallery just to score political brownie points.
Tuesday’s 50 bp cut has surprised the market but Rajan has been clear in the past few months that monetary policy is moving to an accommodative phase and that conditions to spur growth are now needed. He has dropped enough hints to that effect in newspaper and television interviews. It is another matter that investors chose to ignore that and focus on the so-called hawkish comments on base effects and not being a cheerleader for markets.
With global growth slowing sharply and commodity prices crashing, worries over inflation have receded into the background. The government’s stellar efforts in keeping food inflation under check despite two successive poor monsoons would have emboldened Rajan to be aggressive and cut rates by 50 bp instead of 25 bp.
The question now is what will happen to growth? At 7% GDP, India is now the fastest growing major economy in the world. Some sections of the economy are under stress but there are others like affordable housing, roads, urban consumption, cars and heavy trucks that are doing well. The first quarter results stripped of the performance of PSU banks, metals and Tata Motors show revenue growth in high single digits and profit growth in double digit for the main companies.
It is tempting to think that Rajan’s cuts and those by banks will help improve consumption and demand while giving a fillip to investments. But reaility is not so simple. Retail loan growth, both home and personal loans, have been growing quite strongly despite high interest rates so they will probably grow faster after today. Bank profits will improve and so will corporate profitability and some debt-laden companies will get savings in interest costs. But will that be enough to revive overall profitability given the fact many metal and commodity chemicals are reeling under the double whammy of high interest burden and plunging global prices. One has to wait and see how this plays out. Secondly, investments are going to take a long time to recover. This is especially true in sectors like steel, metals, petrochemicals, refining which normally comprises the big capex runbning into billions of dollars. Investments in car and truck plants, smart phone facilities, scooter plants and factories that churn out soaps and detergents may continue to happen but the amounts involved are relatively small in comparison. Public sector capex has already revived in the past six months and this will continue to grow but these companies rely less on public sector banks and more on market borrowings for their needs and some have already seen lower interest costs. This is where much of the growth will come.
Rockstar Rajan has done his bit to revive sentiment and hopes on Tuesday like he did in 2013 and the next two years should see the economy turning around like the currency as companies go for growth. Rajan has done his bit to rescue India twice in two years. That is much more than what any politician has achieved.
(Source – ET)