Home >Opinion >Columns >Opinion | Scope for further easing restricted to 25-50 bps in 2019-20

Acting on expected lines, the monetary policy committee (MPC) cut the repo rate by 25 basis points to 6%. This is the first instance of a back-to-back rate cut by the MPC, following a similar rate action in the February meeting. With this move, monetary tightening carried out over the first half of the previous fiscal year has been fully reversed.

The decision to cut the repo rate was supported by four out of the six MPC members. With Consumer Price Index (CPI) inflation prints remaining benign and below the Reserve Bank of India’s (RBI’s) projections in the last quarter of FY19, along with growth losing steam in the second half, some more monetary stimulus to support growth was expected.

In fact, considering the recent data on growth and inflation, the underlying forecasts for both have been revised lower for this fiscal. Further, in a bid to improve transmission of lower policy rates to bank lending rates, RBI has allowed an additional 2% of net demand and time liabilities (NDTL) carve-out from banks’ statutory liquidity ratio (SLR) to qualify as high quality liquid assets for meeting the liquidity coverage ratio (LCR) requirement over the next one year. Banks, by the end of the fiscal 2019-20, will be able to use 15% of their NDTL under the facility to avail liquidity for LCR from 13% at present. That would help increase the net lendable funds available with banks and enhance the flow of credit.

That said, for more meaningful and faster transmission, liquidity conditions in the banking system need to shift towards a net surplus, compared to persistent tightness over the second half of last year. The guidance on future action through the policy stance was left unchanged at neutral.

That suggests that future easing will be dependent upon either inflation undershooting the forecast path for FY20 or growth slipping below the expected trajectory on lower demand. The baseline inflation projections for the fiscal year see headline CPI inflation gradually picking up over the second half of the year, but remaining below the 4% target rate throughout the year–2.9% in the first quarter, 3% in Q2, 3.5% in Q3 and 3.8% in Q4. Embedded in this forecast path are assumptions that monsoons in 2019 will be normal, helping to keep any food inflation pressures in check; oil prices will average around $67 per barrel, and fiscal deficit will remain around 3.4% of GDP.

The risks to this forecast path remain evenly balanced, i.e., upside risks and downside risks balance out each other at this stage. A sustained spike in oil prices, sharp reversal in the subdued prices of perishables food items, and fiscal slippages are seen as the main upside risks to baseline inflation projections. For instance, the monetary policy report notes that a 1% increase in food inflation from the projected path, can push the headline CPI inflation higher by 0.5%, while a $10 increase in oil prices can push it higher by 0.3%, and vice versa.

Real GDP growth projections for the FY20 see growth improve over the second half of the year in comparison to the relatively subdued growth in the first. For the whole year, growth is expected to be marginally higher at 7.2% as against 7% for the FY19, with risks evenly balanced. Quarterly growth projections suggest that the current negative output gap would persist until at least Q1, which, in turn, would help soften core inflation, which remains sticky above 5%.

Going forward, the scope for further easing of policy rate is restricted to another 25-50 bps in the current fiscal year, but now that is likely to happen in the second half of the year. Fiscal strategy of the new government would have a bearing on the space for further easing, as continuation of an expansionary fiscal policy may reduce the scope for more monetary stimulus. In fact, measures such as income support schemes to counter rural sector distress could push overall inflation higher, if they are introduced without adequate subsidy rationalization or revenue augmentation. A change in stance to accommodative can happen earlier, if GDP growth underperforms or inflation continues to undershoot.

Rate decisions aside, RBI will continue to ensure that any autonomous and durable leakages of liquidity through persistent capital outflows or increase in currency in circulation are managed through open market bond purchases and through the dollar-rupee swap route. Even a cash reserve ratio cut can be used for the first time since 2013. Provision of adequate liquidity will be crucial for ensuring that lower rates help support growth through higher investments and consumption.

Gaurav Kapur is chief economist of IndusInd Bank Ltd.

The views expressed are personal.

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