Room for a rate cut

Siddhartha Sanyal | Updated on October 03, 2019 Published on October 03, 2019

Inflation, growth trends reflect the need for one

The Monetary Policy Committee of the RBI looks set to continue with its “accommodative” monetary policy stance and to deliver more rate cuts in the coming months. Another repo rate cut in the October MPC meeting is widely expected. In fact, the key question is whether the committee will deliver a relatively large repo rate cut (say, 35 basis points or more) or a smaller one (say, not exceeding 25 bps) in October.

After the RBI’s unconventional 35 bps repo rate cut in August and a markedly low Q1 FY20 GDP figure, expectations for another large cut in October had gathered strength. However, the government’s recent announcement of corporate tax cuts and the possibility of a wider-than-budgeted fiscal deficit have created doubts whether the MPC will still deliver a large rate cut in October.

Admittedly, the likely wider-than-budgeted fiscal deficit can be an issue for the MPC to ponder carefully. However, going by the RBI’s flexible inflation targeting mandate, the primary focus of the committee should still be growth-inflation dynamics. In that context, it is of utmost importance that both inflation and growth trends in India clearly offer room for further easing despite the government’s recent decision of lowering corporate tax rates.

CPI inflation stayed below the RBI’s median target of 4 per cent for a long time and averaged sub-3 per cent in the last one year, reflecting softer core and food inflation. Despite adverse geopolitical events, crude oil price was range-bound and inflation expectations stayed anchored. Headline CPI might register some uptick during the second half of FY20. However, that will likely be transitory and largely be a reflection of a markedly adverse base effect rather than due to demand over-heating.

On the other hand, the Q1 GDP growth of 5 per cent, the lowest in over six years, reflected weakness in several pockets in the economy. Nominal GDP growth — at around 8 per cent during the quarter — also tanked to a multi-quarter low and remains a headwind for near term business sentiment.

Given the ongoing rate cuts and liquidity infusion by the RBI, supportive steps from the government, and a materially favourable base effect during the latter part of the financial year, growth rates in H2 FY20 are expected to move higher. However, recovery in the same will likely be only gradual, suggests a host of lead indicators. On balance, as against the RBI’s existing projection of 6.9 per cent, headline GDP growth may come in close to only 6 per cent during FY20.

Real rates still high

Real interest rate in India remains high; the repo rate is about 220 bps higher than the CPI at present. While RBI Governor Shaktikanta Das refrains from targeting any particular level of real interest rates, the case for lowering the same from its current level remains strong at this juncture. The more dovish policy stance of central banks globally also offers the RBI greater elbow room.

The government’s big bang cut in corporate tax rates can potentially be a strong positive over the medium to long run. However, it is unlikely to act as either as a strong near-term boost for growth or as a major threat for the inflation trajectory in the coming months even if the move eventually leads to wider-than-expected fiscal deficit during FY20.

To sum up, thus, trends in growth and inflation clearly suggests that room for monetary easing is still sizeable, despite the tax cuts.

The writer is Chief Economist of Bandhan Bank

Published on October 03, 2019
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