The Reserve Bank of India (RBI) surprised by refusing to cut rates last week. Given a slowing economy, low consumption and no obvious trigger to lift the spirits, the central bank was widely expected to drop the policy rate for the sixth time in succession. Instead it decided to keep the repurchase rate (repo) unchanged at 5.15 per cent (with the reverse repo at 4.9 per cent) and also made no other changes. It has revised growth expectations down sharply.
Multiple considerations are involved in monetary policy decisions. There are inflation and inflation expectations. There are growth expectations. There’s the exchange rate and associated trade considerations. There is the fiscal deficit, which impinges on the government borrowing programme and impacts the bond market.
The RBI is supposed to target consumer inflation and keep it at 4 per cent or as close to it as possible, within a band of plus or minus 2 per cent. Consumer inflation is running at 4.6 per cent year-on-year (October 2019 over October 2018), if you consider the Consumer Price Index. That’s a 16-month high but the driver is mainly food inflation.
Core inflation, stripped of food and fuel prices, is at 3.4 per cent, which is much lower. The Wholesale Price Index is way lower, at just 0.16 per cent YoY. That is a 40-month low. Food prices are volatile and may abate soon (or rise). But the WPI and core rates suggest inflation isn’t a problem.
The repo rate is actually of little relevance right now. It hasn’t been having an impact on commercial rates or bond yields. Lending rates have barely moved down in the last year, though the RBI has cut repo five times, by a cumulative 1.35 per cent.
The Monetary Policy Statement claims transmission of policy rate cuts is now improving, with commercial rates easing down.
Massive government borrowing is one reason for bond yields staying high. Another issue is the never-ending NPA (non-performing asset) crisis. Until corporate revenues and profits recover some growth momentum, NPAs will remain a problem. In addition to banking NPAs, there are NBFC defaults. New issues have arisen with Mudra NPAs and the Karvy case. These are not very large in quantum but they indicate other stress points in the financial system.
Global growth expectations remain dismal. Japan is edging into recession again. The US-China trade war has not been resolved. Brexit is a live issue. The EU is close to recession. The US growth engine is still doing well but there are signs of slowdown there as well. From India’s point of view, this means poor export prospects, but it also has the silver lining of lower fuel and commodity prices.
The likelihood of low growth in 2020 means that major central banks such as the US Federal Reserve
and the ECB will be looking at monetary easing measures and pushing rates down, if growth slows. The People’s Bank of China has held rates steady for a while but it may be tempted into monetary easing, given slowing growth.
Fiscal deficit projections are alarming. The government has hit its full-year fiscal deficit target months ahead of schedule. The corporate tax cut means more foregone revenues. GST (goods and services tax) collections have been poor, even in the festival month of October. There is almost zero chance that the 2019-20 Budget tax collection targets will be met. This means more borrowing and higher bond yields.
Finally, there’s the exchange rate. The trade deficit is high, but it may decline due to lower imports. Lower imports would be due to lower demand which is, however, a danger signal. The rupee has strengthened a little against the Euro, and weakened a little against the USD, GBP and Yen in the calendar year.
A strong rupee is not healthy given a large trade deficit and falling exports. The current account deficit has dropped.
Reserves have swelled, due to strong foreign portfolio investment inflows. The rupee could appreciate more in the short run and that’s quite the wrong medicine. Imports would become cheaper than local produce.
The RBI has cut GDP growth expectations for 2019-20 to 5 per cent. One focus area is ensuring enough liquidity for the government to carry out its borrowing without pushing up yields. Another area must be to encourage the rupee to weaken. It remains to be seen if this is accomplished.