With the spread of COVID-19 increasing, a 40bps repo rate cut in 2Q2020 is expected to offset the economic drag of the virus, and address financial stability concerns.
By Pranjul Bhandari and Aayushi Chaudhary
With the spread of the COVID-19 outbreak increasing, the FOMC cutting rates by 50bps in an unusual intermeeting move, and several central banks across the world likely to follow suit, we believe the Reserve Bank of India (RBI) will also act sooner rather than later.
Our long held view was for a 25bps repo rate cut in 2Q2020. We just added 15bps more of easing to that, and are now expecting a cumulative 40bps of rate cut in 2Q2020, taking the repo rate to 4.75%.
The second quarter will have two official meetings—in April and June, respectively. We expect a bulk of this easing, i.e. 25-40bps, in April itself. Alongside, we also expect the central bank to undertake supportive liquidity measures.
There is a chance that this monetary easing (both the rate cut and liquidity measures) could begin even before the April policy meeting, although much depends on the state of the financial markets over the next few weeks.
The spread of COVID-19 could potentially impact India’s economy via two channels. The first is lower imported inputs from China hurting domestic production, and the second is lower domestic and global growth hurting the demand for Indian goods and services.
The former channel could impact sectors such as pharmaceuticals and automobiles, which depend more heavily on imported inputs. One can argue that rate cuts don’t necessarily help during a supply shock. However, they can help indirectly, by keeping financial conditions loose and improving sentiments.
The second channel is more demand driven, and can be addressed directly by central bank rate cuts. All told, loose monetary policy can potentially help both in addressing financial stability concerns as well as limiting the economic consequence of COVID-19.
In the early-February policy meeting, India’s central bank revealed its preference for supporting growth even at a time inflation was elevated. While the MPC chose not to cut rates—although it did mention that space for easing in the future does exist—RBI went ahead with some unconventional easing (via long term repo operations (LTROs) and some regulatory easing) in a bid to improve transmission.
With inflation likely to fall gradually over the next few months, we believe RBI will continue to be supportive of growth, via both rate cuts and loose liquidity.
Worth noting that much of the onus at this point may fall in the shoulders of monetary policy, because the fiscal space is constrained. Triggering the escape clause in its February budget, the central government announced a fiscal deficit target of 3.5% of GDP in FY21, versus 3% announced earlier.
The details show that there is huge dependence on asset sales (of Rs 2.1 lakh crore) to meet this 3.5% fiscal deficit target. We believe that the government may not be able to reach such a high target (especially given the fragile equity markets), and may end up with a wider deficit of about 3.7% of GDP in FY21. Finding space for much widening beyond this could be tricky.
Finally, on the growth front, we are yet to see the clear signs of COVID-19 in India’s activity indicators. The February PMIs, for instance, have been strong. We believe our newly minted India Growth Tracker will be useful in picking up the early signs of any impact. We intend to update it in the middle of each month.
Excerpted from HSBC Global Research’s India Economics Comment: More Easing, Sooner, March 4, 2020.
Bhandari is Chief economist, India, & Chaudhary is Economist, HSBC Global Research. Views are personal