Opinion | Another rate cut on the cards amid growth slump2 min read . Updated: 03 Jun 2019, 12:20 AM IST
The argument for a rate cut is bolstered by the need to address lack of credit availability
The June meeting of the Reserve Bank of India’s (RBI’s) monetary policy committee (MPC)takes place amid unusual circumstances.
Now that election uncertainty has been resolved, there is an emerging consensus across markets, economists and policymakers that the economy, and particularly the financial sector, needs support in terms of both prices and liquidity. We expect that RBI will respond to this with a third straight 25bps repo rate cut.
The macroeconomic backdrop to this MPC meeting is challenging. The slowdown in activity, which began in October 2018, appears to have become broad-based, with manufacturing, financial services and discretionary consumer durables spending rapidly losing steam.
Further, subdued government expenditure during the pre-election period and limited fiscal room for post-election stimulus should weigh on RBI’s 7.2% gross domestic product (GDP) growth forecast in FY19-20, which we believe may be subject to a downward revision. From a growth perspective, the external backdrop is unsupportive, with trade tensions threatening global demand, causing the negative output gap to further open up.
Since India’s growth is likely to slip to a five-year low in Q1 2019, the MPC may also respond with an accommodative approach, and RBI will want to offer assurance to markets that it will maintain systemic liquidity so that growth is not disrupted for want of credit.
The argument for a rate cut is bolstered by the need to address weakening credit availability. Non-banking financial companies (NBFCs) remain in turmoil, representing a significant bottleneck in the supply of credit to micro, small and medium-sized enterprises that also flows through to discretionary consumer demand.
Though RBI has been pro-active in easing rules around NBFC borrowing and has been injecting liquidity into the system, further support through a cut in the policy rate would be beneficial in mitigating financial sector worries.
Inflation remains benign. We expect core inflation to broadly converge towards the headline in coming months, with one-off price pressures from housing, health and education due to the Seventh Pay Commission fading away. This, in our view, points to a modest inflation path going forward, even amid signs of perishable food prices bottoming out.
Though the usual uncertainty around monsoon rainfall will linger till July, we think high stockpile levels should help suppress food inflation. As such, we see a chance that where the last two MPC cuts were decided on 4-2 votes, this combination of weaker growth and falling core inflation may yield a unanimous decision.
RBI’s inflation forecasts are close to the lower end of current market projections, and we do not see much room for these numbers to be lowered. The MPC under governor Shaktikanta Das might make greater use of the +/-2% range around RBI’s inflation target of 4% to help propel growth.
While there has been speculation around potentially a bigger rate cut in June, we believe Das may emphasize the need to ensure transmission of the cumulative 75bps rate cuts, before accelerating the pace of monetary support.
The MPC may also prefer to wait for the government to present its budget—most likely in early July—in order to assess the government’s appetite for following through on campaign pledges of fiscal support against the need to rein in government expenditure.
Rahul Bajoria is regional economist at Barclays.