Home >Elections 2019 >Opinion >Inflation, growth concerns may lead to deeper rate cut

Inflation and growth are pulling in different directions, but when it comes to monetary policy, we believe growth concerns will weigh in far more heavily. That is why we expect the Reserve Bank of India (RBI) to cut the repo rate by another 25 basis points (bps) during its 5 December monetary policy review meet. It could cut deeper as well.

Gross domestic product (GDP) growth for the second quarter this fiscal came in at a 26-quarter low of 4.5% year-on-year. Inflation, as measured by the consumer price index, spiked from 4% in September to 4.6% in October. However, the shrinking growth rate is far more worrisome. Indeed, a number of data points have been on a free fall since the last policy review. The core sector contracted 5.8% in October. Although retail inflation has spiked, core inflation has fallen sharply, underscoring that demand is slipping. The RBI had noted in October that the widening output gap gave it leeway to cut rates. This gap would only have widened anew and is expected to remain so this fiscal.

Hence, we believe that RBI would ignore the noise in inflation from idiosyncratic factors such as rising vegetable prices and cut the repo rate. Even some fiscal slippage on the government’s part may not be inflationary because of capacity overhang in manufacturing and the output gap.

With recovery an uphill trek, we also expect RBI to lower its growth outlook for fiscal 2020 from its current estimate of 6.1%.

That’s because weakness in the real estate sector and stress in the financial sector have been feeding on each other, sharply pulling growth down over the past few quarters. A slowing world, falling trade intensity, and uncertainties stemming from trade conflict are hurting, too. Moreover, the ongoing clean-up of the financial sector and attempts to improve credit culture is making this slowdown atypical.

All things considered, Crisil has revised its GDP forecast for fiscal 2020 to 5.1% from 6.3% earlier.

We believe the economy will bottom out in the third quarter and expect some recovery in growth in the second half at 5.5% compared with 4.8% in the first half.

The mild pick-up will be likely helped by a better rabi crop following abundant rain, the lagged impact of the repo rate cuts announced so far, the spillover of recent pick-up in government spends, and a weak base effect. That said, recovery will be feeble, given that the financial sector clean-up would stretch the slowdown, particularly when policy space for a stimulus is limited.

Where does that leave monetary and fiscal policy action in the short run?

Finance is the lifeblood of the economy and the immediate cost of scrubbing the financial system is slower growth. Authorities have to be vigilant to ensure that stress at some non-banking financial companies does not generalize. Speedy de-stressing of the financial sector will help lift sentiment and enhance monetary policy effectiveness, too.

We have seen monetary policy lose some of its bite in the current milieu. Despite a cumulative repo rate cut of 135bps by RBI this year, lending rates have come down by only 20-30bps. If a slowing economy has reduced demand for credit, risk aversion and weak sentiment have diminished the willingness to supply credit, too. Non-food credit growth slipped to 8.1% in October.

The government, on its part, is trying to rev up its consumption spend to support the economy. Government consumption expenditure, at 15.6% year-on-year growth in the second quarter, was the fastest-growing part of GDP.

However, fast-tracking non-tax revenue generation via divestments and asset monetization becomes very important to keep the fiscal deficit under check. That’s important because investment growth has flat-lined at 1% and no noteworthy revival is on the cards.

Dharmakirti Joshi is chief economist at Crisil Ltd.

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