GDP shock not a trigger

By Indranil Pan

The sweet-spot story for India may be eroding as the recently announced GDP data shows that all might not be well for the Indian economy, both from the demand side as also from the supply side. Especially as the GDP growth has now entered a sub-6% zone, unanticipated by many, including the Reserve Bank of India (RBI). As recently as the October policy, the RBI had indicated its confidence on the growth momentum as it moved the monetary policy stance to “neutral”. At the October Monetary Policy Committee (MPC) meeting, the RBI continued to risk a forecast of 7.2% for the full-year FY25, even as it saw the Q1 numbers missing its own estimates of 7.1% and registering an actual outturn of 6.7%. For the Q2FY25, the RBI estimated a growth of 7% but this has once again been missed significantly with the actual outturn of 5.4%.

To achieve the RBI’s estimated 7.2% GDP growth for FY25, the H2FY25 growth should be at 8.4% and this seems to be an unlikely tall order after H1FY25 growth of 6.1%. Surely the RBI would have to accept the slip in its own estimates and bring down the growth target for the year — possibly to around 6.5%. Having accepted that growth is slowing, the question that needs an answer is, will the RBI be reactive enough to immediately launch itself into a repo rate cut?

First, we think that the sharp slowdown in the manufacturing sector (on the production side) and the slowdown in personal consumption (expenditure side) is due to the aggravated rainfall in certain parts of the country. Importantly, the slowing trend is also due to the slow pace of government expenditures, especially on the capital side. Remember, capital expenditures of the government were the key for the sharp turnaround in economic activity post-Covid. Gross fixed capital formation (GFCF) was down 3.2% quarter-on-quarter (q-o-q) in Q1FY25, mostly due to elections. It was expected that government spending would pick up post-elections, but even for Q2FY25, GFCF is down by 0.5% on a q-o-q basis. The finance ministry is reported to be pushing various other ministries to speed up spending and thus, one can hope for a more stable growth trend in the remaining part of the fiscal.

The economics team at YES Bank is not calling for a repo rate reduction at the December meeting. Apart from growth, which is no doubt important for policymakers, the mandate for the RBI is inflation and there is some discomfort over there. Between the October and the December meetings, the MPC has seen two inflation readings — the first for September at 5.5% and the next for October at 6.2%. The trajectory has been on the higher side and the upper end of the targeting band has been breached. True, the major component responsible for this breach is vegetable prices, which have came down in November by around 10%. This implies that the November reading will be lower than that of October, but the monetary authority will probably have to wait a bit longer for confirmation on the inflation prices trending durably to 4%. According to our current model estimates, the average headline consumer price index (CPI) inflation should be around 5.3%, another miss from the RBI’s own estimates of 4.8%. For FY26, we expect headline CPI inflation at 3.9-4%, sans any ugly swing in vegetable prices.

With this type of inflation projection one year ahead, there is no doubt a monetary easing is in the offing. But the timing is important as the RBI is currently pushed into making a very delicate choice. From the monetary policy angle and with the consideration of financial stability, restrictive monetary policy measures along with other macro-prudential measures have led to the credit deposit ratio of the banking sector correcting lower, while the froth in the unsecured loan has been reduced. 

The RBI has probably now largely achieved its objective of derisking the financial sector; and with the banking sector slowing its loan growth, there was no doubt that a slower growth was in the offing. The RBI will also have to keep an eye on the INR depreciation trends.

Trump’s policies on higher tariffs and a US fiscal push are likely to be inflationary for the rest of the world. Policy authorities in India would have to take cognisance of this. The final word on when the policy repo rate might be moved lower may not be in December, but there is now a fair chance for this to happen in February after an understanding of Trump’s policies and their impact on global supply chains is taken into consideration.

More than a policy rate cut in December, the markets have become vocal for a cash reserve ratio (CRR) cut. The argument is that the government surplus has vanished, and systemic liquidity deficit is looming large. To my mind, it is too early to argue for a CRR cut as we expect the government to speed up spending to an extent. The seasonal tightness in liquidity could anyways be due as we head into the year-end in March, but that should sort itself out as we enter the new financial year. 

What we and the RBI would not have a handle on immediately is the extent to which the latter would have to erode its forex reserves to stop a currency depreciation and having a negative impact on domestic rupee liquidity. Thus, the RBI will have to cross the bridge when it comes to it. As we write, for November 29, the RBI had absorbed Rs 500 billion through its liquidity operations.

Finally, no rate cut is expected in December, and a possible start to the rate-cutting cycle could be seen in February. The RBI may not sound too worried about the rupee’s liquidity position and may convey its willingness to act as the situation evolves.

The writer is chief economist, YES Bank.

Disclaimer: Views expressed are personal and do not reflect the official position or policy of FinancialExpress.com. Reproducing this content without permission is prohibited.