– Macro backdrop supports a rate cut
– Global outlook also conducive to a rate cut
– But will RBI pause in light of recent fiscal stimulus?
– Shouldn’t RBI wait for earlier rate cuts to be transmitted first?
There is near consensus in the markets that the Reserve Bank (RBI) will cut its policy rate on October 4.
While the macro backdrop of benign inflation and weak growth point to such a cut, the large dose of fiscal stimulus and the consequent slippage might prompt the RBI to pause. The question is: Will the RBI let the earlier rate cuts and the recent fiscal push play out or will it try to add to the “feel good” factor with another rate cut?
In the current calendar year, the central bank has slashed rates four times by 110 basis points.
While the markets were pricing in no rate action post the “big bang fiscal stimulus” announced on September 20, 2019, the recent softening in yields is suggestive of a token rate cut.
The repo rate at 5.40 percent is still 65 basis points higher than the low of 4.75 percent it touched in April 2009. But that was during the aftermath of the global financial crisis.
The perfect backdrop for a rate cut
Inflation has been benign and in spite of the slight uptick in headline numbers in recent times, it remains well within RBI’s range of 3.5-3.7 for the second half of FY20.
India received above-normal rainfall — 9 percent above long period average (LPA) as on September 29 — even with a weak and delayed start to the monsoon. Sowing for the kharif season matched last year’s level and significant surplus in reservoir levels is a good sign for the rabi crop.
On the global commodities front, the growth outlook remains benign, thanks to the US-China trade war. Despite a temporary spike in crude prices due to the drone attack on Saudi oilfields, global commodity prices continue to soften.
Source: Moneycontrol Research
With the inflation outlook subdued, the focus clearly is on reviving growth. In the previous monetary policy statement on August 7, 2019, the RBI had lowered the growth forecast for H1 FY20. In light of the very low GDP print of 5 percent in Q1 FY20 that was announced after the previous policy, it would be interesting to see RBI’s take on growth.
The fiscal heavy lifting
However, unlike earlier policies, where the onus of heavy lifting was solely with the monetary policy and hence, markets were looking at disproportionately high rate cuts from the RBI, the scenario has changed post the recent fiscal stimulus in the form of corporate tax cuts.
A section of the Street argues that if most of the exemptions were removed, the actual fiscal impact of the tax cut would be lower than the Rs 1.45 lakh crore as estimated by the government; nevertheless, the threat of significant fiscal slippage looms large because of low tax collections, both direct and indirect.
Sure, a part of the fiscal slippage would be offset by the extra dividend from the RBI, but it remains to be seen how far the government resorts to expenditure compression, given the severe slowdown. As the government accounts suggest, so far in the current fiscal year, the negative impact of sluggish tax revenue has been countered by higher non-tax revenue and slower growth in expenditure.
Fiscal and monetary measures may not work like magic
Nevertheless, the Centre’s measures to boost growth such as sops for exports, real estate and the recent corporate tax cuts could help growth somewhat, though it may take some time for the benefits to flow into the economy.
It remains to be seen if the RBI prefers to wait and watch, especially since the monetary transmission has not been very effective so far and starting October 1, 2019, the RBI has mandated banks to link their loan products to an external benchmark such as the repo rate for faster transmission of lower policy rates to borrowers. However, given the recent spate of corporate defaults, asset quality concerns are resurfacing which might limit smoother transmission of policy rates.
The RBI needs to be also mindful about the currency which has seen weakness in recent times.
While the macro backdrop does not rule out a further rate cut, the scope is limited, given the fiscal pressure; and a pause too cannot be ruled out, with the RBI preferring to wait for the impact of earlier monetary and fiscal action to play out.
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