RBI Monetary Policy Review: Get over rate cuts, transmission is the key

August 6, 2019 7:00 PM

The renewed US-China trade tensions have prompted a sharp fall in Yuan to record low levels, with the US administration retaliating with terming China as a currency manipulator.

RBI, MPC, policy, transmission, rate cuts, repo rate, CRR, SLR, ratio, lending rate Global economic slowdown has become more pronounced, with trade war bringing back the risk of a currency war.
  • Upasna Bhardwaj

Over the last few days, the sentiments have changed dramatically, both domestically and globally. The renewed US-China trade tensions have prompted a sharp fall in Yuan to record low levels, with the US administration retaliating with terming China as a currency manipulator. The global economic slowdown has become more pronounced, with trade war bringing back the risk of a currency war. India too has been bracing with weak economic conditions. Yesterday’s political developments have further led to significant volatility in the financial markets.  The MPC will be meeting on 7th August in this gloom doom backdrop. RBI in the June policy meeting had revised down the FY20 GDP by 20bps to 7%. We see significant risks to these forecasts given the continuing stress from consumption, income uncertainties, falling saving rates, and the tight financial conditions for SME segment amidst the credit crisis.

We, thus, have revised down our GDP estimates to 6.3% from 6.8%. Inflation also continues to remain well within RBI’s 4% target, with moderating core inflation clearly reflecting the weak demand-side pressures. With inflation in check and growth continuing to surprise on the downside, we believe the MPC will have more room for monetary easing. We expect 50-75bps of rate cuts in the subsequent meetings, with 25bps likely in tomorrow’s meeting itself. While we do not completely rule out an outside chance of a larger cut given the worsening global and domestic outlook, we continue to believe that rather than aggressive repo rate cut monetary transmission and liquidity stance remains key. 

Monetary transmission in India has always been with a significant lag and it should not be any different this time as well. The cumulative 75bps of policy rate cuts are yet to reflect on the lending rates. The transmission in this cycle could be further impeded given the relatively high credit-deposit ratio, elevated administered rates, record-high public-sector borrowings, and credit crisis. The much-awaited liquidity management framework could lay the path for smoother and faster transmission if several questions are addressed. There is a need to provide clear guidance on the compatibility between policy and liquidity stance.

For instance, in an accommodative policy stance reverse repo rate could be operational while in a neutral to tightening stance repo rate could remain as the operative rate. Furthermore, clarity on the durability of liquidity surplus will be crucial for transmission. Despite the onset of rate cuts in February, liquidity continued to remain deficit until May, restricting transmission. The spread between 1-year PSU CD and weighted average call (WACL) rate had hit a peak of ~178bps in February, which now has eased to ~93bps (current WACR is 5-10bps above reverse repo), highlighting the importance of durability of liquidity. However, the liquidity stance and the sustenance of the surplus remains uncertain and hence any guidance on liquidity stance could aid transmission.   

Overall, weak global and economic outlook, tight credit conditions and still-deficit monsoons amidst limited fiscal headroom puts the onus of stimulus on the MPC. However, we continue to highlight the importance of transmission and hence liquidity stance for effective monetary easing.

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