The October monetary policy committee (MPC) meeting decision will be delivered amid two important developments—a massive fiscal stimulus post a shocking Q1FY20 gross domestic product (GDP) growth and linking of the lending rates of banks with external benchmarks from 1 October.

While the recent announcement of fiscal stimulus of 0.7% of GDP has not cast doubts on the possibility of a rate cut of 25bps on 4 October, it has trimmed down expectations of future rate cuts. Many believe that the case for repo rate to be reduced below 5% post the announcement of fiscal stimulus has weakened significantly. Thus more than the rate action—we expect a 25 bps reduction in repo rate to 5.15% in October—the market will closely watch the MPC’s assessment on growth for the future quarters.

In our view, while the corporate tax reduction is a medium-term positive, its impact on growth is likely to come with a lag. Given that it tackles supply-side issues, it is unlikely to address the weakness in demand in the immediate horizon. Additionally, a study by the Reserve Bank of India (RBI) in 2013 estimates the tax multiplier at 0.1-0.5 and notes that tax multipliers are usually less than expenditure multipliers. Thus, even as the announcement trims downside risk to growth by boosting sentiments, it’s unlikely to push India towards 7% growth anytime soon. Thus, with a likely downward revision in the GDP growth projection for the year ending March 2020 by the MPC at 6.4%, which is a significant downward revision from its August policy, further opening up of output gaps should keep the possibility of more rate cuts high in our view. The much weaker than expected level of economic activity should also keep worries on inflation contained as core inflation can move lower offsetting upside pressure from increased geopolitical tensions and rising food inflation on weather-related issues. While a huge fiscal deficit can cause some discomfort, we believe it is unlikely to shift the MPC’s focus away from growth.

The case for a dovish MPC and more future rate cuts also exists because of the recent linking of the lending rates of banks to external benchmarks such as the repo rate. We expect the terminal repo rate at 4.75% by FY21. While the move, which will be effective from 1 October, will ensure quick transmission of future rate cuts to the economy, it is likely to limit the transmission of past rate cuts, which have been 110bps since February 2019. Thus if the MPC wants to support growth by lowering rates significantly, it will probably have to walk an extra mile and take the repo rate lower than 5%. Recently, the RBI has put out its much-awaited internal working group report on liquidity management framework for public comments. It refrained from proposing too many changes in the current framework. While the RBI is still likely to give assurances of providing adequate liquidity to the banking system in the next meeting, its non-committal status on surplus liquidity is likely to weigh on the rates market and thus the transmission of rate cuts till now. The market had hoped for a liquidity framework that committed to liquidity in +\- 1% of net demand and time liabilities and the alignment of liquidity stance with the monetary policy stance. This proposal of an almost unchanged framework in our view indicates that MPC members will have to rely more on rate actions to provide monetary stimulus to the economy.

Overall, we believe that the stance and tone of the monetary policy statement is likely to remain dovish. The MPC members are likely to flag concerns on issues such as rising food inflation and huge fiscal deficit.

However, we believe they are likely to keep the door wide open for more rate cuts. Besides the domestic issues, global uncertainties do not provide the comfort to indicate the end of the easing cycle just as of now.

Anubhuti Sahay is a senior economist at Standard Chartered Bank

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