MUMBAI -- The Reserve Bank of India on Wednesday slashed its forecast for real economic growth to 6.7% this fiscal year ending March, from its prediction of 7.3% in August. RBI uses gross value added growth as a measure of economic growth instead of usual gross domestic product.
Its monetary policy committee voted to keep the key interest rate unchanged at 6% earlier in the day. Although RBI shrugged off the government's call for a cut to boost the sluggish economy, it surprised markets by taking steps to release liquidity into the financial system.
The RBI said it would lower the statutory liquidity ratio -- the amount of bonds that banks must set aside with the central bank -- by 50 basis points to 19.5% from mid-October. It had lowered the ratio by the same amount in June.
Five of six members of the monetary policy committee voted in favor of keeping rates steady, while one voted in favor of a cut of 25 basis points.
The committee, headed by RBI governor Urjit Patel, justified its action by saying in a statement: "The MPC observed that consumer price inflation has risen by around two percentage points since its last meeting. These price pressures have coincided with an escalation of global geopolitical uncertainty and heightened volatility in financial markets due to the U.S. [Federal Reserve's] plans of balance sheet unwinding and the risk of normalization by the European Central Bank."
It noted that there was a likelihood of the output gap widening, "but requires more data to better ascertain the transient versus sustained headwinds in the recent growth prints."
Patel also expects inflation to rise to 4.2-4.6% by the end of 2017, prompting experts to predict that the RBI may not cut rates at its next meeting in December too.
The consumer price index, which was at a five-year low in June, rose to 3.36% in August largely due to costlier food items. There are fears that inflation might breach the central bank's target of 4% as a result of the impact of normal monsoons on food prices, the new goods and services tax, and rising global crude oil prices.
The MPC last cut benchmark rates in August, the second such action since its formation in October last year.
It called for the government to improve severe infrastructure problems in the country, restart stalled investment projects, particularly in the public sector. To encourage investment, the MPC said that the government should ensure ease of doing business including by simplifying GST. It should also roll out an affordable housing program and cut excessively high stamp duties imposed by state governments.
The committee reiterated that it was important to reinvigorate investment activity which, in turn, would revive demand for bank credit. It also called for the recapitalization of banks to spur further lending.
Pressure for growth
The committee has been under pressure for a rate cut, as the government is desperate to jumpstart the economy, encourage lending and boost consumption.
Gross domestic product fell to a 13-quarter low of 5.7% year-on-year in the three months ended June. Current account deficit, on the other hand, expanded to 2.4% of GDP, a four-year high. On the fiscal deficit front, the government has utilized 96.1% of its budget in just the first five months.
The economy has been shaken to the core by the government's crackdown on black money in November and a subsequent roll-out of the complicated GST in July.
"The worsening of recent macroeconomic data has changed the narrative around India from positive to negative," Normura said in a note on Oct. 2. "Murmurs of a fiscal stimulus have added to concerns that policymakers may sacrifice macro stability for growth."
However, Nomura said that consumption stimulus was not yet necessary as real private consumption rose 7% year-on-year during the first half of 2017 with government consumption rising 23.2% due to its front-loaded spending.
Nomura said: "What the government needs to do, in our opinion, is address three challenges (namely): resolve the supply-side disruptions, including working-capital needs, caused by the GST as quickly as possible; faster NPA resolution and adequate recapitalization of public sector banks; and evaluate ways to kick-start the investment cycle, including fast-tracking execution and raising more off-budget resources".
Prime Minister Narendra Modi last week formed a panel of experts, the first since he came to power in 2014, to suggest ways to spur growth. The panel is expected to move swiftly, given that the Modi government has less than two years left in its tenure. But experts reckon that any solution to fix the economy could take more time than Modi had in the run-up to the 2019 elections.
India was the world's fastest growing major economy until recently. In the April-June period of 2016, it grew 7.9%. In January-March this year, growth had slowed to 6.1%.