Fourth consecutive repo rate cut expected in August MPC review
With the CPI inflation remaining well below the Monetary Policy Committee’s (MPC) medium-term target of 4%, and a variety of indicators pointing towards performance faltering across sectors, a fourth consecutive repo rate cut of 25bps appears on the anvil in the August 2019 policy review.
In June 2019, the MPC had placed its CPI inflation forecast at 3.0-3.1% for H1FY20 and 3.4-3.7% for H2FY20, with the risks broadly balanced. Subsequently, delayed kharif sowing, rising vegetable prices, low reservoir levels and an uptick in domestic fuel prices have emerged as risks. Such factors, as well as an unfavourable base effect, may push the headline CPI inflation above 4% in some months of H2FY20, even as the average will remain sub-4% for this fiscal.
In ICRA’s view, while there appears to be room for further rate cuts, we do not expect considerable additional monetary easing, going forward. The focus may shift to faster and fuller transmission to both deposit and lending rates, particularly since systemic liquidity is in ample surplus. Additionally, several constraints to a pickup in economic growth, such as moderate capacity-utilisation levels and cost of land acquisition, may not be dissipated by lower interest rates.
Moreover, the MPC had revised its GDP growth outlook downwards to 7% for FY20 in the June 2019 review from its earlier estimate of 7.2%. The recent data prints across indicators are raising concerns regarding slowdown in economic growth. Auto production and non-oil merchandise exports contracted in Q1FY20. Also, the core sector growth came in at a marginal 0.2% for June 2019, suggesting that industrial growth is likely to print at an anaemic sub-1% level in that month, extending the sequential slowdown recorded in May 2019. Further, earnings growth has been subdued in several sectors other than banking in Q1FY20, which would weigh upon the GDP growth for that quarter. The outlook for domestic consumption, exports and private investments is muted, even though government spending may pick up in the post-Budget months.
The first half of the monsoon season has been unfavourable, which would constrain farm income growth from kharif crops, even if the remainder of the season witnesses normal rains. The year-on-year decline in reservoir levels so far does not portend well for the rabi season, which would keep rural sentiment subdued. And, exports growth is unlikely to be substantial in the current global environment.
Private investment may remain muted in the near term. The low visibility of a sustained uptick in capacity utilisation, as well as the availability of brownfield assets through the NCLT, suggest that capacity expansion is not warranted in many sectors. Further, some businesses are facing issues related to refinancing of existing debt. The continuing high leverage levels of various corporates, and the low likelihood that many banks would want to pursue project finance lending, would prevent a quick revival in investment activity, even if transmission of monetary easing improves and lending rates decline.
Notably, government of India’s (GoI) revenue expenditure recorded a modest growth and capital spending contracted in Q1FY20. However, government expenditure is expected to record a pickup in the last three quarters of this fiscal. While GoI’s revenues are typically disproportionately higher in the later quarters of each fiscal, and some of the tax proposals made in the Budget would support tax collections in the remainder of the year, at present, we can’t rule out that expenditure cuts may be required to prevent fiscal slippage, if revenue targets are not achieved. On balance, based on available data, we expect GDP growth to print 6.7% in FY20, lower than the MPC’s forecast of 7%.
The market will continue to monitor the evolving fiscal trends of the GoI and parse the MPC’s statement and minutes to glean the outlook for additional monetary easing. However, the size and timing of the sovereign bond issuance would impart a disproportionate effect on the yields of G-Secs in the remainder of 2019. ICRA expects the 10-year G-Sec yield to trade in a range of 6.2-6.6% in Q2FY20.
(The writer is Principal economist, ICRA.Views are personal.)