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Will the RBI cut rates today? Fiscal boost also needed to battle slowdown

Despite global central banks cutting interest rates, the RBI, so far, has adopted a cautious approach.
Interest rate cuts have become the go-to tool whenever a country finds itself in the midst of a market-related instability or an economic slowdown. The recent coronavirus (Covid-19) outbreak, too, has led to a clamour for a rate-cut to support the sentiment.

Understandably so, the US Federal Reserve (US Fed), in a surprise move, cut its key interest rate to a target range of 0 per cent and 0.25 per cent on Sunday. The cut comes close on the heels of a rate cut done on March 3. Bank of England, last week, too, cut its interest rates in an emergency move to bolster the economy, as did central banks of Australia and New Zealand on Monday.

Despite this, the US stock futures were locked in their lower limit on Sunday (Monday for India), after entering into a bear phase (down 20 per cent from the top) last week.

The Reserve Bank of India (RBI) is expected to hold a media interaction later in the day today. It is widely expected that the central bank will cut rates and announce measures to boost sentiment.

So, is the monetary action not enough? Maybe, say analysts.

According to JP Morgan, interest rate cuts may not assuage investors who are dealing with twin shocks of a slump in crude oil prices and the outbreak of Covid-19, leading to a sharp repricing in global markets, including in equities, fixed income, commodities and currencies.

“More than interest rate cut, the most important role for central banks to play is to ensure that liquidity remains ample. While investors have gotten addicted to monetary policy responses during this cycle, the more important reaction is actually from fiscal policy,” the brokerage notes.

Apart from the first order impact of the virus, JP Morgan cautions the governments across the globe, about the need to prevent second-order effects, especially from “social distancing”, such as job losses and bankruptcies.

“This would include several microeconomic measures that can provide support to affected small and medium businesses and their workers. This would help to soften the short-term negative impacts of Covid-19 and would help to strengthen the eventual rebound. It is crucial for people to have jobs to return to and businesses to go back to when life goes back to normal,” it underlines.

Devendra Pant, chief economist at India Ratings and Research, too, calls for a mixed action-plan - a combination of rate cuts and fiscal boost.

“We need monetary action, right now, to ensure that businesses – whose cash flows or working capital have been hit due to lack of demand in the wake of the virus outbreak -- don’t suffer when the economy crawls back to normalcy, and they don’t default on their loans,” he explains.

RBI unmoved - for now

Despite global central banks cutting interest rates, the RBI, so far, has adopted a cautious approach. While there were no rate cuts till Monday, the central bank undertook currency swap operation of $2 billion to safeguard the rupee’s value against the US dollar.

“Going ahead, we expect the RBI to buy $18 billion of forex forward to contain bond yields to make room for open market operation (OMO) ” say analysts at BofAML.

“What India needs is a mix of monetary and fiscal boost… While a rate cut may still be given, government doesn’t have the space to provide fiscal stimulus,” Pant of India Ratings says, adding that the fiscal stimulus provided now would have to be prudently reversed when the coronavirus is curtailed.

The fall in crude oil price, therefore, can be a blessing for India in this case. According to estimates by BofAML, the fall in crude oil prices could lead to a potential boost of Rs 500 billion or 0.4 per cent of GDP to consumption, after the Rs 3 excise duty hike, is passed on to the consumer.

A boost in public spending through say, higher interest rate subsidies on mortgage or SME loans to support consumption demand, are some of the ways through which Centre could provide stimulus.  

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