Weak growth may force India’s central bank to reconsider inflation focus

September 1, 2015

Reserve Bank of India Governor Raghuram Rajan speaks to The Economic Club of New York, in midtown ManhattanFor all its single-minded focus on lowering inflation, India’s central bank may be forced to acknowledge slowing growth in Asia’s third largest economy by cutting interest rates — probably faster than it expected.

The Reserve Bank of India has so far resisted calls from the government and businesses to ease policy rapidly and instead focused, almost with a hawk’s eye, on inflation.

Governor Raghuram Rajan even started his term a couple of years back by raising interest rates in order to fight stubbornly high inflation — a chronic problem in India.

But a global disinflation trend since last summer has eased price pressures in India, pulling inflation to a record low.

Just last week, economists polled by Reuters gave a 60 percent chance of the Reserve Bank of India cutting its benchmark repo rate when it meets later in September.

If delivered, that would be the fourth repo rate cut this year and round up the steepest policy loosening cycle in India since the global financial crisis over half-a-decade back.

RBI Governor, Raghuram Rajan, speaking on the sidelines of the annual central bankers summit at Jackson Hole in the U.S. last week, signalled he wasn’t done easing rates.

We are on a phase of accommodation. We are still in that phase. We are looking at the data to see what more room we have.

Indian economic growth slowed in the quarter to June, coming in at 7 percent, 0.4 percentage points below the consensus, exactly matching China’s reported rate of expansion.

The news, and a fresh bout of weakness in factories across Asia and Europe, sank India’s benchmark stock index by over 2 percent on Tuesday. But the BSE Sensex is in a much better spot than that of its northern neighbour, China, and even other emerging market peers.


In the previous quarter, growth was 7.5 percent under a new accounting method that attracted much flak for painting a rosier picture of the economy than was real.

Still, the RBI cut its benchmark repo rate two times between January and March this year as inflation cooled.

There isn’t much confidence on the latest GDP data either, with many economists cautioning even the 7 percent growth rate should be taken with a pinch of salt.

Shilan Shah, India economist at Capital Economics, wrote:

The official GDP data are overstating the strength of the economy, most probably by a significant margin. The key point is that they remain inconsistent with numerous other indicators which suggest that, at best, the economy is in the early stages of recovery after three years of tepid growth.

Indian factory growth slowed in August despite deep discounting, according to a private survey.

With Monday’s GDP data coming despite the new calculations, concerns have risen that the economy is weaker than the official numbers suggest.

That raises the odds of a rate cut in India at the end of this month. That contrasts with the U.S. Federal Reserve, which is widely expected to hike its benchmark federal funds rate sometime this year, possibly when it meets in just a few weeks.

The slowdown also pours cold water on expectations that India will power global growth at a time when China’s economy has been hit by investment outflows and slowing activity.

The outlook for long-term Indian growth, however, is brighter.


Government policymakers have also heaped pressure on the central bank in recent weeks, publicly asking the RBI to cut interest rates, although the central bank has held further rate cuts will be tied to the inflation outlook.

In a speech in August, Rajan said:

Rate cuts should not be seen as goodies that the RBI gives out stingily after much public pleading.

Instead, what is important is sustained low inflation and rate cuts are a natural consequence that the RBI has no hesitancy in delivering.

The inflation hurdle is indeed low for now.

Consumer inflation was a record low 3.78 percent in July, weaker than the lowest forecast in a Reuters poll.

The global slump in commodity prices, especially oil, which makes up a large part of India’s imports, will likely pull inflation lower in coming weeks.

Coupled with slowing activity and investor concern over the Narendra Modi government’s inability to enact reforms, the tepid inflation outlook is likely to tilt the onus for supporting the economy to the RBI.

HDFC Bank economists wrote in a note:

We expect the RBI to respond to this by cutting policy rates by another 50 bps over the course of FY16 and we do not rule out a policy move before the next scheduled review on September 29.

The prospect of further easing beyond this remains – another 50 basis points of repo rate cuts in fiscal year 2017 – especially if the financial and economic turmoil in China intensifies and spills over to other Asian economies that have been struggling under the burden of excessive debt and slowing demand.

(With additional inputs by Rahul Karunakar)

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