With the current local and global backdrop, and with obvious constraints on fiscal policy, it is reasonable to expect the current easing cycle to prolong.
By Suyash Choudhary
With the Fed rate cut on Wednesday, major developed market central banks have officially begun the process of easing that some of their developing market counterparts have already embarked upon earlier in the year. Thus the above framework of gauging policy effectiveness via relative changes in domestic financial conditions relative to domestic economic and stability conditions) is a useful way of both monitoring effectiveness of easing as well as in trying to predict the future path of easing for that particular central bank.
While the manufacturing slowdown in India is consistent with the global manufacturing slowdown underway, we have another issue which is more local; that of the slowing consumer. The best sequence that explains this slowdown is this: income growth in India has anyway been weak for the past few years.
However, consumption has been sustained via rising consumer leverage. With the housing and non-bank finance lending squeeze underway for almost a year now, the leverage effect for the consumer may be slowing. There may be a behavioural aspect here as well where with savings already dipping and the incremental environment turning weaker, the consumer is deciding to cut back. Since this slowdown is backed by a substantial fall-off in savings, it becomes that much more difficult to reverse in short order.
In such an environment, there is a role for countercyclical discretionary policy. Fiscal policy is facing exceptional constraints owing to a significant fall-off in expected revenues from GST and personal income taxes. Given this, the finance minister has been prudent in not administering any incremental stimulus. Not just that, she has actually hiked indirect taxes to fill some of the gap. Thus the annual combined deficit when Centre (on and off balance sheet) and states are added is a hefty 8-9% of GDP. However, growth has slowed despite this. That tells to the complete lack of drivers in the private sector over the past few years. There has been no incremental fiscal expansion undertaken in response to the last leg of deterioration in growth. Given this, the role of the other discretionary policy pillar, monetary policy, consequently becomes stronger. The RBI / MPC is already easing via all the three tools at its disposal: guidance, liquidity, and rates. Indeed, this is for the first in recent memory that all three are being used in synchronicity.
With the current local and global backdrop, and with obvious constraints on fiscal policy, it is reasonable to expect the current easing cycle to prolong. At this juncture we are comfortable expecting another 75 bps of rate cuts in this cycle, alongside provisioning of adequate positive liquidity. Risks to the view are from a global turnaround and / or local fiscal policy giving into temptation.
(The writer is head, Fixed Income, IDFC AMC. Edited extracts from IDFC AMC’s Fixed Income report)