While optimists were penciling in a 50bps repo cut, the central bank’s decision to ‘lower the average ex ante liquidity deficit in the system from 1% of NDTL to a position closer to neutrality’ implies banks may end up cutting lending rates by more than the 25bps repo cut—as economists have been arguing, unless there is a sharp increase in liquidity, there will be no transmission; by how much interest rates will fall depends on how many months it take for RBI to make good the liquidity deficit. More important, the policy stance is dovish, indicating the possibility of further rate cuts down the line. The RBI’s CPI projection is around 5% in FY17—though this does not include the likelihood of a 150 bps hike in inflation due to the Seventh Pay Commission recommendations, RBI will overlook that since this is a one-time hike. The indirect/lasting impact could be another 40 bps according to RBI but, presumably, it is hoping this will be compensated for by the impact of global deflation. Indeed, it is global deflation that ensured a 5.4% CPI in Q4FY16 versus RBI’s projection of 5.8%. Not only is the current $40 oil much lower than the $50 in H2FY16, as the central bank points out, a 1% slippage in global growth could reduce India’s GDP growth potential by 20-40 bps and lower inflation by 10-20 bps; oil falling to $20 could reduce inflation by 80-120 bps.
That said, the question is whether this will move the growth needle. RBI has projected GVA rising from 7.3% in FY16 to 7.6% in FY17 and 7.9% in FY18—while a normal monsoon will cause that much of a spurt this year, it is important to keep in mind the big growth stimulus of falling oil prices will most likely not be available this year and slowing global growth will also impact India. Since the Pay Commission stimulus will be countered, to a certain extent, by lower government expenditure, what happens to investment is critical. While there has been a pick-up in new investments in the March quarter, it is difficult to make too much of it given the extreme volatility of the data. HSBC’s analysis of CMIE data shows stuck projects are rising—to 8.4% of GDP in the March quarter—though the good news here is that this number falls to 5.8% if you exclude minerals/metals that are driven by the global commodity cycle; what also helps is that a third of projects are stuck due to lack of clearances or raw material and so can be resolved through executive action. Tuesday’s repo cut and the likely transmission by banks will help stimulate demand a bit and lower interest costs for India Inc, but a significant shift in GDP will have to wait.