RBI might go for a 20-25bps cut in the October policy and then wait to see how oil prices and fiscal deficit move.
By Shanti Ekambaram
Since February 2019, the Reserve Bank of India’s (RBI) monetary policy has been doing most of the heavy lifting, cutting the repo rate by 110 basis points (bps), in an environment where inflation has remained well within RBI’s medium-term target of 4%. However, when the RBI Governor-led Monetary Policy Committee (MPC) meets to release its fourth bi-monthly policy statement for FY20 on October 4, two issues that will be discussed at length are:
Crude oil prices: The recent volatility due to geopolitical tensions and its likely impact on India’s fiscal deficit and corporate tax reduction and thus the fiscal bazooka unleashed by finance minister Nirmala Sitharaman. Given the growth slowdown, it was absolutely the need of the hour, but this fiscal booster shot will likely put a strain on the fiscal deficit, which, in turn, could have a say in the monetary policy. Economists at Kotak have revised the fiscal deficit estimate for FY20 to 3.7% after accounting for fiscal measures. And we expect CPI inflation to trend towards 3.9% by March 2020.
The key question: Can this fiscal bazooka trigger investment, consumption demand and, thus, growth? It was widely expected that fiscal measures would focus on driving demand and consumption. The much-awaited September 20 tax reform by way of a sharp reduction in corporate tax rates is actually aimed at boosting investment. The Rs 1.45 lakh crore fiscal boost to corporate India will hopefully trigger investment, facilitate price cuts to boost demand, and will also attract foreign and domestic investment into the manufacturing sector, giving a shot in the arm to the Make in India initiative given the very attractive tax rates. This, at a time when foreign manufacturing bases in China are looking for alternatives in the Asia Pacific region.
With inflation within the targeted range, it was the right time to administer this fiscal boost as it gives the government the much-needed cushion to be able to stretch the fiscal deficit in the quest for growth. Even as both the financial markets and the corporate India cheered the fiscal stimulus, the worries about slowdown in growth, whether this stimulus can stoke investments and consumption demand and the time lag for the same are real.
I do believe that we will see a slow, trickle-down effect of the fiscal booster to consumers through lowering of prices and increase in wages. This will gradually restore consumer confidence and lead to revival in demand over the long-term. The fiscal stimulus has also come at just the right time with the festive season round the corner, and will give a significant boost to consumer spending.
At Kotak, our FY20 GDP estimate stands at 5.8%, while any pick-up could be seen in the latter part of FY20. Monetary and fiscal policy must work together: Even as the central bank cuts the key policy rate, there is a limitation to what the monetary policy can achieve on its own. While rates have been on a downward trajectory since February 2019, consumption and investments have continued to slow down. This is why fiscal and monetary policies must work together and go hand in hand. The government and RBI are working in tandem to pack a powerful punch for the economy.
Hopefully, we will see a return of the much talked about animal spirits in terms of investments, FDI, revival in manufacturing, creation of jobs and demand. As always, there will be a lead and lag effect between the announcement of the measures and its impact, which, in this case, could be 6-9 months. We will perhaps see the full impact of these measures in FY21.
In the near term, expect the MPC to take a more calibrated stance. There is headroom for the MPC to cut rates as inflation is low. My own expectation is that the central bank will go for a 20-25 bps cut in the October policy and then wait to see how oil prices and fiscal deficit move. Like everyone else, they will also wait to see the impact of monetary and fiscal measures that have been injected into the economy.
The author is president, Consumer Banking, Kotak Mahindra Bank. Views are personal