The Reserve Bank of India (RBI) took a significant step on December 6, 2024, by reducing the Cash Reserve Ratio (CRR) from 4.5% to 4%. This move, after a series of ten consecutive status quo policies, aims to inject more liquidity into the interbank market. The RBI’s decision comes in the wake of selling over $60 billion in the past two months to stabilize the rupee, which weakened following the US presidential election. This intervention led to a contraction of nearly ₹4 lakh crore in the banking system’s liquidity. While the CRR cut is a step towards easing liquidity, it’s important to note that the RBI maintained the repo rate at 6.5%, indicating that the central bank is cautious about further monetary easing.It’s a move in the right direction amid current situation. It’s not prudent to cut the repo-rate. The last inflation number that October printed was above the 6% CPI mandate. It is not practical since rate cuts will not get passed on when banks don’t have enough liquidity. The rule of thumb is, when inflation rises, central banks increase the repo-rate to curb economic activity and control inflation, if the growth outlook is positive. However, the MPC took a different approach by cutting the CRR while keeping the repo-rate unchanged. Let’s find out why?
The central bank recognized that while inflation remains a concern, the economy requires a stimulus to maintain growth momentum. By reducing the CRR, the RBI intends to infuse the banking system with additional liquidity. This increased liquidity empowers banks to lend more loans, thereby stimulating economic activity and fostering growth. The Governor has indicated a wait-and-see approach regarding interest rate reductions. He might have foreseen a decline in the Consumer Price Index (CPI) to 4% in the second quarter of the fiscal year 2026 (July-September 2025). This potential decline in inflation could pave the way for a potential repo rate cut in February 2025.
There is nothing wrong in RBI anticipating that growth will increase. However, by November it was clear that the earning growth had disappointed, there is an urban slowdown and the nowcasting also didn’t turn up. The state of the economy still put that chart at 6.6%, earlier the projection was at 7.2%. However, in our opinion risks are still on the downside from that projections. A full year growth can fall down to 6.4%. Given there is an urban slowdown which is very evident, the credit growth is not really upswinging. So a monetary policy easing could be in the Offing. The central bank has not taken that call at this juncture because there is enormous amount of uncertainty and inflation is just too high at 6.2% it needs to come down to below 5% by December, with a seasonal vegetable price correction. While the RBI’s growth projections may be overly optimistic, the real challenge lies in balancing economic growth with inflation control. We think, the key lies in government increasing its capex. Now as per the data, the capital expenditure from April to October is down by around 15% from the last year. So that’s a big slowdown on the capex front. Which can easily be corrected by the fiscal policy and growth can be supported more from the fiscal side than monetary policy side, given that the inflation is tracking at very high numbers.
Let’s dive into decoding ‘capital expenditure’ because it is an important growth driver. As per the printed data, first seven months the April to October period, the capital expenditure has actually contracted by exact 14.7% as compared to the same period of last year. Also in terms of budgeted expenditure the amount that has been spent is just 42% of the budgeted capex. Budgeted Capex has been around 11.11 lac crore, 42% of that has been spent in the first 7 months. So now, the government has its work cut out for it. To meet its annual spending target, it must shell out a whopping 1.2 lakh crore rupees every month for the next five months. There is a possibility that government might underachieve on its capex target because it’s already on a very high baseline. One reason for capex not picking up was the elongated rains which dented some part of capex formalisation plans but even otherwise both the central government and the state government’s capex formalisation plans have not yet crystalised.
The second reason of it to look at could be the ‘ministries’. Where the capex is picking up and where the capex is lagging. Encouragingly, major ministries responsible for significant portions of the budget, such as roads and railways, which together account for nearly 47% of the total allocation, have shown relatively steady progress in their capital expenditure implementation. As the reports suggests, in the first seven months, the Railways Ministry has achieved 62% of its budgeted target, while the Roads Ministry has exceeded 50%. However, other ministries are lagging behind. It’s crucial to identify these underperforming ministries and understand the reasons for their delay. This analysis will help determine if there’s a need to reallocate funds from less critical projects to those with higher potential for growth and impact. As per the data, the decline in capital expenditure is primarily driven by a contraction in the last three months (August, September and October) consecutively. In each of these months, spending on capital projects was lower compared to the same period in the previous year.
The stringent question here is: Is it only the monsoon that really derailed the capex or are there deeper issues at play? It appears to be a structural problem. The recent slowdown in capital expenditure raises serious questions about the sustainability of aggressive targets. As the budget season approaches (budget to be released on 1 Feb, 2025), policymakers must re-evaluate their approach and prioritize efficient execution over lofty goals of every year keeping (22-25)% growth target of capex. It’s time to focus on the ground reality of implementation because there’s a limit to how much investment the economy can absorb. .
Thus there are lots of expectations from the remaining five months. The capex and revenue needs to ramp-up. It’s a small timeframe and each of these capex plans takes time to execute. While there are some positive indicators like the recent festival season boosting consumer spending and a potential pick-up in rural demand. A glimmer of hope lies in the government’s ongoing efforts to improve supply-side reforms, such as constructing new highways to pare down the logistics costs.
With the RBI slashing its GDP growth forecast for FY25 to 6.6%, the economic outlook to achieve this also appears to be bleak. A rate cut of 50 bps is expected in February 2025 to spur the growth.
