In the lead-up to the October meeting of the Reserve Bank of India’s (RBI’s) monetary policy committee (MPC), the debate is largely predicated on the picture of the economy and its prospects that will emerge, and how that will affect the quantum of the impending rate cut on 4 October.

On the growth front, developments since the last MPC meeting have been enough to create a sense of urgency within the government. The government has provided some hope through corporate tax cuts, but its booster impact on the real economy may require some time and lots of patience.

In the meantime, country’s gross domestic product (GDP) growth is down to 5% in Q1FY19-20, with both consumption and investment losing steam. Add to this, high frequency indicators suggest no turnaround is in sight at least for now, but Q2FY19-20 might also be somewhat distorted by the multiple episodes of weather-related disruptions across the western and eastern parts of India.

We believe the central bank will need to materially lower its GDP forecast for FY19-20, perhaps to 6.2-6.5% from the 6.9% at present. This lower figure will still factor in a material recovery in H2FY19-20.

Amid poor economic data but improving market sentiment, the Reserve Bank faces a trade-off on whether it prefers to front-load the cuts and risk market repricing or extend the easing cycle by signalling a gradual but protracted easing in the future.

The current slump in growth in a benign inflation situation makes a rate cut a foregone conclusion, but the trade-off for the MPC at this meeting will be between keeping the forward guidance of an easing cycle alive versus responding to the fairly weak growth outlook with a larger rate cut.

Our argument for a reduction by a calibrated 25 basis points (bps), in contrast to a larger 40-50bps or a smaller 15-20bps cut, is that RBI will wish to signal that the door to further easing is still open. If RBI chooses to deliver a rate cut of a larger (50bps) or a smaller (15bps) magnitude, we think it would risk incurring the unintended consequence of signalling an imminent end of the easing cycle.

Further, risks around fiscal slippage have re-emerged with the government rolling out the corporate tax cuts, without adding any discussion on how it will be financed. As some members have raised concerns around the fiscal position prior to the tax cuts in previous meetings, delivering a larger rate reduction at this point could risk a divergence of views across the MPC.

By virtue of being a committee, the MPC has so far demonstrated a preference for taking small steps that also have consensus among the members with varying views. A larger rate reduction with diverging views would likely dilute the overall policy message.

We still think risks of a front-loaded 40bps rate cut remain non-negligible, with boosting domestic demand having attained the “highest priority" in the policy pecking order. However, a non-unanimous accommodative stance, along with fiscal risks and an uncertain global backdrop, risks sending a confusing signal to the market. Therefore, we think a calibrated 25bps rate cut, while maintaining an accommodative stance, would yield the maximum benefit for RBI.

Rahul Bajoria is chief India economist, Barclays

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