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After the Centre’s big bang stimulus in the form of a sharp cut in the corporate tax rate, all eyes are on the RBI’s future rate action. After the massive fiscal expansion, will the RBI continue with its monetary easing? Or, will the central bank exercise caution and rein in rate cuts in light of such a significant slip in the fiscal deficit?
A day before the Finance Minister announced the mega corporate tax cut, the RBI Governor, Shaktikanta Das had indicated that there was limited space for fiscal measures. But with the RBI Governor hailing the Centre’s corporate tax cut as a ‘bold measure’, it is now unclear if the RBI would view the fiscal expansion as a deterrent to further rate cuts.
On the data front, growth slowdown in the domestic market and a favourable inflation trend, point to the possibility of further rate cuts. Weakening global growth and a wave of monetary easing across central banks also support further monetary easing by the RBI (though there is less ammunition left with global central banks to address the growth slowdown). On the flip side, though, an expansionary fiscal and monetary policy throw open risks to macroeconomic stability, which need a close watch.
Given all of this, the repo rate can move from 5.4 per cent currently to about 5-5.25 per cent by the end of the fiscal, implying a token one to two rate cuts at best. Since 2000, the repo rate fell to its lowest of 4.75 per cent in April 2009.
Growth and inflation dynamics
Rate actions by the RBI hinge on the growth and inflation dynamics.
On the growth front, the dismal performance in the April-June quarter have heightened concerns on the state of the underlying economy. The real GDP growth in Q1 of the current fiscal plunged to a six-year low of 5 per cent. The slowdown was seen across most segments — mining, manufacturing, and construction. The sharp fall in consumption is a big worry, given that consumption accounts for 55-58 per cent of GDP.
The RBI had marked down its growth estimate for FY20 to 6.9 per cent from 7 per cent earlier in its August policy. But that was before the Q1 GDP growth numbers were disclosed. With the real GDP growth this fiscal likely to end much lower at 6-6.2 per cent (our reading), there is a good possibility that the RBI will cut rates further. The Centre’s measures to boost growth, such as a dole-out for exports, real estate and the recent corporate tax cut, could help growth somewhat, though it may take sometime for the benefits to flow into the economy.
On the inflation front, while CPI inched up to 3.2 per cent in August from 3.1 per cent in July, it is still much within the RBI’s target of 4 per cent. Also, while food inflation inched up slightly, core inflation (excluding food and fuel) continued to move lower.
In the coming months, food prices on a low base may inch up. Also, the recent spike in crude prices may exert upward pressure on overall inflation. On balance, though, given the weak growth in the economy, overall inflation is likely to remain sanguine, keeping open the possibility for further rate cuts.
How much?
While the RBI cutting the rate in the upcoming policy cannot be ruled out, given that the RBI has cut the repo rate by 110 bps so far this year, the extent of future cuts will be limited.
One, in a bid to improve transmission, the RBI has mandated banks to link a new floating rate personal, retail loans and MSME loans to an external benchmark effective October 1, 2019. This should make loans cheaper and, hence, limit the need for an aggressive repo rate cut by the RBI.
Two, the Centre’s big bang fiscal expansion is a dampener. The revenue loss of Rs 1.45 lakh crore on account of the corporate tax cut implies additional borrowings (above the already high ₹7.1 lakh crore for the current fiscal). The likely over-supply of bonds in the second half (unless foreign sovereign bond issuance happens) caps aggressive rate action by the RBI.
Three, while the Fed cut rates by 25 basis points, it stated that the cut was due to the impact of global developments on growth and muted inflation pressures. Hence, the future course of action is unclear as of now. As such, after consistent and aggressive monetary easing efforts, global central banks have little ammunition left to tackle the growth slowdown. Against this backdrop, the RBI has limited scope for sharp rate cuts hereon.
Finally, a weak rupee may also play truant. If the RBI does a sharp rate cut at this juncture, it could dissuade foreign flows into the Indian debt market. The flows into debt have slowed considerably in September, so far, and may need a watch. From Rs 8,000-11,000 crore in the past three months, net inflows into debt in September (up to Septemer 23) slowed to Rs 1,385 crore.