Since the April 2019 monetary policy review, domestic growth momentum has weakened and risks to global growth have increased.

So, a 25 basis points (bps) cut in repo rate on 6 June should be no surprise and the market has baked that, as reflected in sliding gilt yields. The decline in US treasury yields is also conducive to a slicing.

What’s more, fiscal 2019 was the second straight year of slowdown with gross domestic product (GDP) growth slipping 40 bps to 6.8%. In the last quarter of last fiscal, GDP growth slipped to a 20 quarter low of 5.8%.

High-frequency data, too, shows that the cyclical downturn has intensified with broad-based weakness in manufacturing.

The easing of the Purchasing Managers’ Index for April means that weakness in manufacturing could linger. Exports, too, were flat in April and the escalation of the US-China trade war creates a slippery slope in the coming months.

And a decline in core inflation in April confirms rising slack in the economy.

That means two factors will be crucial to growth this fiscal: monsoon and crude oil prices. Both are a function of luck. If rains are normal and well distributed, and crude oil stays below $70 per barrel, GDP growth can pick up to 7.3% this fiscal—also helped up by the statistical low-base effect of last fiscal.

If both turn the wrong way, India will need a material countercyclical stimulus.

We expect consumer inflation to print to 4% this fiscal, 60 bps higher than the previous as food inflation normalizes over a low base and converges with core inflation, which is coming down.

Past trends reveal that wholesale price index (WPI)-based food inflation “Granger causes", or temporally precedes, consumer price index (CPI) food inflation.

So, the increase in WPI food inflation, which touched 7.4% in April, is expected to show up in CPI food inflation over the coming months.

The good part is that rising overall consumer inflation is unlikely to morph into generalized high inflation because of the slack in the economy and lowered inflation expectations.

As for fiscal and monetary policies, they have become growth-supportive. Fiscal deficit at 3.4% of GDP (higher than projected under the Fiscal Responsibility and Budget Management Act) has created some space for spending. This will marginally support consumption demand. Any further slippage can be potentially inflationary and will reduce the scope for monetary easing.

A key problem area in the economy remains monetary transmission. It has always been weak and asymmetric over policy cycles. Rate increases transmit, or spread, faster to lending rates than decreases.

No surprise, therefore, that despite two rate cuts since February, lending rates have hardly declined—despite the switch to marginal cost of funds-based lending rate, and despite the linking of borrowing rates to external bench marks.

Additionally, structural factors such as higher small savings rates continue to act as a floor for deposit rates and therefore lending rates.

To be sure, transmission is also weak at this juncture because of tighter liquidity.

In the road ahead, how much rate cuts will stoke and buffer the economy will depend on how effective their transmission is.

The market would look up to the RBI to turn this wheel well.

Dharmakirti Joshi is chief economist at Crisil Ltd.

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