A favorable environment of political stability and low cost of capital with adequate liquidity can help kick-start the much needed investment boost to the economy.
By V K Vijayakumar
The April 4 th monetary policy meet will be the last policy meet before the crucial general elections. Even though the monetary authority need not bother about elections, the political economy is too significant to ignore. It is important to have a favorable investment climate before the new government takes charge. A favorable environment of political stability and low cost of capital with adequate liquidity can help kick-start the much needed investment boost to the economy.
It is desirable to shift to accommodative stance
Inflation trajectory has been benign and is likely to remain so for several months to come. For FY20 the headline inflation is likely to average around 3.8 percent, well within RBI’s target. The RBI has been undershooting its inflation and GDP growth forecasts consistently in the recent quarters. Since both inflation and growth are lower than projections, it is time to change the policy stance once again: this time from neutral to accommodative.
CPI inflation is currently at 2.57 percent (February). This means that with repo at 6.25 percent, real rates are well above 3 percent, which is excessive in a slowing economy. RBI did the right thing in the last policy meet to change the stance from ‘calibrated tightening’ to neutral. The time is ripe to change the stance now to accommodative and send a strong dovish message. This will enable the market to discount further rate cuts.
25 bp cut in policy rates
There are many experts who are arguing for a 50bp rate cut in the coming policy meet. This may be desirable but is unlikely on the eve of the general elections since such a move is likely to invite criticism that the RBI under the new governor is acting in tune with the government’s wishes. Therefore the RBI can be expected to cut policy rates by 25 bp with a dovish commentary.
Time for a CRR cut
Even though liquidity conditions have improved following OMOs and dollar swap by the RBI, further easing of liquidity is desirable. This can be achieved through a CRR cut of 25 bp, which beside improving liquidity will also help improve the profitability of the stressed banking system.
An important issue is that of monetary transmission. Due to tightness of liquidity in the system and poor deposit growth, the transmission has been poor. But the recent RBI initiative of dollar swap has been a very good move and continued OMOs can certainly address the liquidity issue. In brief, the time is right for a rate cut of 25 bp, a 25bp cut in CRR and a change in stance from neutral to accommodative with a strong dovish commentary.
(The author is the Chief Investment Strategist with Geojit Financial Services. The author’s views expressed in this article are personal.)