The lower-than-anticipated growth exposes severe gaps in the understanding of the RBI and its forecasting division

Last week, Prachi Jhamb and I had given a revised forecast in these columns which had a lower bound at 4.6 while growth for the second quarter (Q2) was estimated at 4.5 per cent. So, we were quite close to the actual figure. But a sub-five per cent growth has raised major questions and challenged conventional wisdom around India’s economy, especially in the 21st century. Till last year, most believed five per cent to be the lower bound on the country’s growth. That is, even during a slowdown, our growth would be at five per cent. This was based on the new Gross Domestic Product (GDP) series which was better at capturing economic growth as compared to the previous one, in critical sectors. Consequently, everyone believed that the first quarter (Q1) and Q2 figures would go low at 5 per cent.

However, this belief changed the moment our Q1 growth figures touched five per cent and now with the Q2 at 4.5 per cent, one must be careful before commenting on what this lower bound is. More than the bottom, these figures expose the lack of ability of the Reserve Bank of India (RBI) to factor in these “unknowns” while formulating our monetary policy. For instance, despite a lot of us forecasting a lower growth for the current financial year, till recently the RBI’s forecast was at seven per cent. It was then downgraded to 6.1 per cent, which now appears to be too optimistic.

It is safe to assume that the RBI didn’t anticipate the extent of the economic deceleration, which should be more alarming, given that in 2018 it increased interest rates twice. A sudden hike in interest rates in 2018 coincided with a major liquidity crunch in the Non-Banking Financial Company (NBFC) space which curtailed extension of last-mile credit. Therefore, are we surprised that growth was lower than the Q2 of the previous financial year in which it was at 7.1 per cent? The Central bank needs to ask itself some serious questions as it got the forecast wrong and failed to gauge the impact of its decision on the money markets.

Given how it has also witnessed lapses in discharging its regulatory functions, the RBI direly needs to address issues in some of these areas. A modern Central bank is a necessity for creating a vibrant, dynamic and sustained high-growth economy. Unfortunately, so far, we’ve not yet seen the kind of policy response from the RBI that is warranted. More so, because a major reason behind the current crisis is policy choice and, therefore, the inability to acknowledge a mistake is perhaps acting as an impediment from doing “whatever it takes” to fix the economy.

Some may say that the RBI has cut interest rates by 135 basis point but in 2008-09, the Central bank reduced rates by 425 basis points at a time when both inflation and nominal growth was higher. We certainly have two separate yardsticks for the conduct of the monetary policy. With a nominal growth of 6.1 per cent, our prime lending rate and even our Government 10-year-bond rate is higher and this reveals the extent of our wonky monetary policy.

One hopes that the Monetary Policy Committee (MPC) will take note of it and take urgent corrective measures, such as a deep rate cut that is beyond 50 basis points, combined with a series of Open Market Operations (OMOs) to drive transmission. The elephant in the room is the monetary policy and unfortunately, the Government can’t do much about it because, the moment it intervenes, a debate regarding the Central bank’s independence gets triggered.

Once transmission improves and lending rates come down, EMIs should gradually reduce and people will be left with higher disposable incomes. Low levels of inflation warrant low levels of interest rates and hopefully by the end of this crisis, we will be converging towards the same. This is important for the real estate sector as high interest rates have caused a prolonged period of subdued demand along with a build-up of inventories and stressed assets.

There’s a silver lining in the recently-released GDP data as it shows a revival of consumption expenditure, which means that growth in the second half could be better. The Goods and Services Tax (GST) collections for October, too, support this hypothesis, so we may be gradually moving towards a five-plus growth rate for the second half of the financial year. A bulk of the growth in Q2 came because of Government expenditure.

This shows that the economy is responding to fiscal measures, so not curtailing expenditure and not being too rigid concerning the deficit, are likely to stabilise the situation over the next two quarters. A good takeaway of the low growth figures is the debate regarding India’s growth statistics as the official series is adequately reflecting the state of the economy. The other casualty is the forecasting ability of the RBI and one hopes that there are significant resources deployed to improve the same over the coming years.

(The writer is a New Delhi-based policy researcher)