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Photo: Reuters
Photo: Reuters

Opinion | Concerns over growth come to the forefront

One more repo rate cut of 25 basis points is likely in the August meeting

The monetary policy committee (MPC) has delivered broadly in line with expectations with a 25bps rate cut and a dovish guidance with an accommodative policy stance. It has acknowledged the need to support growth given that inflation looks to remain well within the Reserve Bank of India’s (RBI) 4% target over the foreseeable future. While the return of government spending and the concerted effort to boost consumption may help support consumer demand, there’s very limited fiscal flexibility. Given the limited fiscal space, we see further downside risks to growth in the near term. We expect FY20 GDP growth to remain muted at 6.8%, with slowdown in 1H likely to continue and some improvement in consumption and investment likely in 2H. However, core inflation is expected to remain muted even as food reflation begins. Overall, headline inflation is expected to remain near the 4% mark (+/- 50bps) over the next 9-12 months.

We see one more 25bps of repo rate cut in the August meeting with further easing expected only if any downward surprises to the RBI’s existing growth-inflation outlook materialise. Further, we see some upside risks to food inflation surfacing in 2HFY20 in contrast to RBI’s expectation of large correction in food prices during autumn and winter. Given the rural distress and the emphasis of the government in boosting farmer incomes, we do not expect food prices to be capped meaningfully. Nonetheless, while the impact of cumulative 75bps of rate cuts gets assessed we need to focus on the monetary policy transmission. RBI has constituted a working group to evaluate the existing liquidity management framework the details of which may be available in July. In the new liquidity framework, RBI may want to assess the need to make the liquidity stance in sync with the policy stance. This can partly be achieved by looking at changing the operative rate closer to the reverse repo (rather than repo) in an accommodative cycle and vice versa. This could provide clarity on a definitive stance on liquidity, thus creating room for effective monetary transmission. However, we need to realize that keeping liquidity in surplus mode is not a sufficient condition as banks’ limited ability to raise low cost deposits given the high administered rates on small savings has been eroding the transmission channel. Normalization across small saving rates and pickup in lending by PSU banks could begin to ease pressure and allow for smoother transmission to aid growth.

The growth dampeners are not just lack of liquidity but credit squeeze, insolvency and confidence crisis emanating from the NBFC space. While the assured banking liquidity surplus condition may not ease credit concerns, smoother monetary transmission could seek to mitigate the adverse impact brewing of the NBFC sector slowdown. We hope to see a continuation of reforms to uplift the economy towards high growth in the long term. Besides the already existing focus of the government on boosting infrastructure, housing and farm income, and the strong mandate should allow the government to focus on reforms like revamping the land and labour laws, agricultural reforms, facilitating the IBC process, faster resolution of NPAs and curbing tax evasion.

Upasna Bhardwaj is senior economist, Kotak Mahindra Bank.

The views expressed are personal.

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