India's Central Bank Passes the Buck Back to the Government

(Bloomberg View) -- At their meeting on Wednesday, the makers of India's monetary policy cut interest rates only marginally. They would seem to have had little choice -- but also little confidence that a deeper cut would jumpstart the Indian economy.

The preceding days and weeks had featured a deluge of worrisome data, all of it pointing in the same direction: the economy was slowing down, perhaps dangerously so. The index of industrial production, for example, which measures manufacturing and mining output, grew by only 1.7 percent in May 2017 as compared to a year earlier. Similarly, in June, output in eight “core” industries grew by only 0.4 percent over the previous year. And even as the Reserve Bank of India's monetary policy committee was meeting, they received news that the Nikkei India manufacturing purchasing managers index had dipped below 50, indicating the sector was contracting.

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Meanwhile, inflation has remained benign. The consumer price index hit a new low in June, at 1.5 percent. Food prices, the usual driver of Indian inflation, had begun to fall some time earlier. The RBI has committed itself to targeting 4 percent consumer price inflation and corporate leaders had begun to ask why, if the economy had slowed, rates weren't being cut to match. The government joined the chorus, with its chief economic adviser insisting that there had been “a paradigm shift” to lower levels of inflation. He followed that up with a barely veiled attack on the RBI's stubbornness, talking of “large, one-sided and systematic inflation forecast errors."

Beset on all sides, the RBI cut rates by 25 basis points, bringing the benchmark repurchase rate down to six percent -- the lowest since November 2010. But, to its credit, it flatly refused to accept the notion that inflation had reached some new, permanently lower level. The policy committee's statement argued instead that “a conclusive segregation of transitory and structural factors driving the disinflation is still elusive." Intellectually, then, the RBI has given no ground to its critics.

And the central bank is standing firm in another way, too. The monetary policy committee doesn't seem to believe that the cost of capital is to blame for India's stalling private investment, and that therefore sparking growth is the RBI's responsibility. The last section of its statement is quite clear as to what is responsible: stressed balance sheets, yes -- but also infrastructure bottlenecks and slow project clearances.

This will surprise those who thought that administrative dilatoriness was a problem that ended with Narendra Modi's ascent to the prime minister's office in 2014. Modi's party runs the central government and most of India's states. But the RBI seems to be suggesting that the slow speed of project approvals remains a major constraint on growth. The committee pointedly noted that the number of new investment announcements had fallen to a 12-year low, and called out “the lack of traction in the implementation of stalled projects.”

In other words, the RBI is not going to come to Modi's rescue. A 25-basis point cut in the policy rate had been priced in already -- and given that inflation is almost certainly going to rebound in a bit, there's not much chance of another cut anytime soon.

More to the point, the RBI is right and the government is wrong. The problem with private investment is not, primarily, the cost of capital. The problem is the unwillingness of banks, already struggling with souring loan portfolios, to lend or of overleveraged companies to borrow. At the same time, administrative paralysis means too much capital is still tied up in stalled projects.

According to the Centre for Monitoring the Indian Economy, 12.3 percent of all projects -- both public and private -- were stalled in the first quarter of 2017. That's the third-highest level recorded since June 1995 and the first time since 2004 when over a fifth of private-sector projects have been stalled. This isn't a problem that can be solved with a 25- or even a 50-basis point cut in the headline policy rate.

The message from India's central bank to the government is loud and clear: Work harder to fix the economy. The Modi government took three years to start addressing India's slow-motion banking crisis. Let's hope it doesn't take as long to unblock stalled projects.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story: Mihir Sharma at m.s.sharma@gmail.com.

To contact the editor responsible for this story: Nisid Hajari at nhajari@bloomberg.net.