Is RBI due for another interest rate cut? Why MPC has tough job at hand this time

Updated: December 3, 2019 12:04:25 PM

The RBI’s FY20 GDP estimate for FY20 will be revised downwards as we observe some economists on the street have lowered their GDP estimates to sub 5% for FY20.

The fiscal deficit for 7 months ending October 2019 is 102.4% of the budget estimates for FY20.

By Sudhakar Shanbhag

When we look at the last 2 years macro indicators of GDP growth and CPI inflation as also the RBI’s repo rate we observe that growth from a peak of 8.1% in Q4 FY18 has dropped to a low of 4.5% in Q2 FY20 which is also a 26 quarter low, whereas CPI inflation from a level of 2.11% in Q3 FY19 has gone up to 4% in Q3 FY20. The nominal GDP has come in at 6.1% for Q2 FY20 and just about 7% for the first half. The RBI’s FY20 GDP estimate for FY20 will be revised downwards as we observe some economists on the street have lowered their GDP estimates to sub 5% for FY20. The recent data on imports and exports also demonstrates a slowdown in the domestic and global economy. Since January of 2019, the Reserve Bank of India has cut repo rates by 135bps to account for easing inflation in the early part to growth concerns in the second half.

The fiscal deficit for 7 months ending October 2019 is 102.4% of the budget estimates for FY20. Gross tax collections grew by 1.2% versus a budgeted number of 11%. Revenue and capital expenditure have grown by 13.6% during this period. If we consider the actual nominal GDP growth rate of 7% versus budgeted 12% and the shortfall in revenue which is apparent at this stage, the combined effect of these two will lead to a fiscal deficit of about 3.9% at best.

Growth inflation conundrum

The 5th Bi-monthly Monetary Policy Statement is due on December 5, 2019.

October 2019 CPI inflation at 4.62% has breached the RBI’s comfort zone of 4% and is likely to remain above its comfort for the rest of the year. The MPC members view on whether the recent increase in food inflation is transient will be crucial. Crude Oil though in the range of $60 to $64 has been in an acceptable range from our countries perspective. On the back of subdued economic activity, the core inflation is at a multi-year low level of 3.3%.

In terms of liquidity in the system, the levels seem to be adequately demonstrated through the LAF absorption levels. The transmission of rates reduction continues to be a challenge and the level of government borrowing with moderation in household savings, in combination continues to crowd out private investment demand.

If the MPC members believe that the recent increase in food inflation is transient and assign a higher weight to the moderating core inflation, they may continue to focus on reviving growth and look through the recent and upcoming inflation readings. They may then go ahead with the rate cuts believing that maintaining accommodative financial conditions in this subdued environment is essential. MPC members’ perception of ‘flexible inflation targets’ will be tested in the December policy. While there is room for monetary easing amid weakening growth, higher inflation trajectory poses risks to the pace and quantum of rate cuts.

(The author is Chief Investment Officer, Kotak Mahindra Life Insurance Company Limited. The views expressed are the author’s own)

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