BackOpinion | Passing on rate cuts to revive the growth cycle is the real challenge
All members of the MPC were unanimous in their decision, with a subtle difference
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ith an eye on raising the sagging economic growth, the Reserve Bank of India’s (RBI’s) monetary policy committee (MPC) on Wednesday delivered its fourth consecutive rate cut by a rather unconventional 35 basis points (bps), taking the benchmark repo rate to the lowest since July 2010. That there is a synchronized rate-cutting cycle playing out across the globe further supported the decision.
The move was in line with market expectations of a continued dovish stance of RBI. Given fiscal constraints, the onus of reversing the cyclical downturn in the economy had fallen on monetary policy.
What were the immediate cues?
On the domestic front, the risks to India’s growth have been rising against an environment of benign headline inflation and falling core. Little surprise, then, that all members of the MPC were unanimous in their decision to cut rates with a subtle difference—four of them voted for a 35 bps slicing, and two for 25. Slashing it by 50 bps would have been excessive and 25 inadequate, said the RBI governor.
The rate cut also comes against greater global uncertainties since the last policy meet, amid benign inflationary outcomes. The US has taken its tariff spat with China one notch up by slapping fresh 10% duty on imports from that country. This has deepened trade-related uncertainty, adding downside to an already weakening global investment and growth trajectory.
All this has made the policy stance of central banks, and forward guidance in advanced economies, more accommodative. The US Federal Reserve delivered a 25 bps “insurance" rate cut in July. The European Central Bank postponed the rate lift-off cycle this year and is using forward guidance to convey its accommodative stance. The Bank of Australia delivered a surprise rate cut last month and New Zealand central bank slashed rates by 50 bps. Such synchronous rate-cutting makes it easier for emerging markets to pare their interest rates to support growth.
So, how does fiscal 2020 look from here?
RBI cut its GDP growth forecast to 6.9% with risks tilted to downside. Crisil, too, had recently lowered its GDP growth forecast for FY20 by 20 bps to 6.9% following inadequate monsoon rains, slowing global growth and sluggish high-frequency data for the first quarter.
Domestic growth will be led by household consumption in FY20, as private investment decisions are likely to be pushed back and public investments remain constrained. The improving terms of trade for agriculture and farm income support, though, are positive for rural consumption.
Dependence on public funding, and the ability of government institutions to borrow and enable execution will limit infra spend in key segments such as roads and urban infrastructure. Besides, private sector participation in these segments remains weak.
Will the rate cut spur growth?
The ability of monetary policy to revive demand depends on the transmission of repo rate cuts to the cost of borrowing for households and businesses. This had remained chronically sluggish until recently, particularly with regard to bank lending rates. Interest rates in market-linked instruments, such as bond yields and commercial paper/certificates of deposit rates have, however, come down.
That said, the accommodative stance, surplus liquidity and reduction in risk weights for consumer loans should improve monetary transmission and support growth better by the second half of the fiscal year. The rate cuts would help growth grind up, at best. But watch out for downside risks.
Dharmakirti Joshi is chief economist at Crisil Ltd.
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