Reserve Bank will go for another rate cut

At the Mumbai launch of former Reserve Bank of India (RBI) governor Y V Reddy’s latest book Indian Fiscal Federalism (co-authored by G R Reddy), Governor Shaktikanta Das referred to Reddy’s tenure as “continuity and change… mixed together appropriately” — something which Reddy himself had said on assuming office in September 2003.

When Reddy’s turn came at the launch function, he spoke about the change in the approach of the new governor too. For the record, in his five-year tenure, Reddy had never cut interest rate even once but Das cut the rate at his very first monetary policy meeting. Of course, during the Reddy regime, it was a governor’s policy; now the monetary policy committee (MPC) decides on the rate action. 

I will not be surprised if there is yet another rate cut on April 4 when the MPC concludes its first meeting in the new fiscal year. But how much? Will it be an encore of February — a 25 basis points (bps) cut? Or, will the RBI frontload the cut, going in for a deeper 50 bps? One basis point is a hundredth of a percentage point.

In February, the RBI cut the policy rate to 6.25 per cent — the first such cut since August 2017. It also changed the policy stance from “calibrated tightening” to “neutral”. At that time, taking into account the continuing deflation in food items and moderation in fuel prices and, assuming a normal monsoon in 2019, the RBI revised its retail inflation projection downwards to 2.8 per cent for the March quarter of 2019, 3.2-3.4 per cent in the first half of fiscal year 2020 and 3.9 per cent in the third quarter of 2020, with risks “broadly balanced”.  

India’s headline inflation rose to 2.57 per cent year-on-year in February, driven by the so-called base effects as well as a pick-up in food inflation, reversing a declining trend since July 2018. Indeed, food inflation remained negative for the fifth consecutive month but, on a sequential basis, it rose significantly. 

While the inflation has started rising, why should the RBI go for a rate cut? Well, even though the February figure was higher than what analysts had expected, the March quarter inflation will be lower than the RBI estimate and the average retail inflation for fiscal year 2020 is likely to be below 4 per cent. Indeed, the oil price has risen but that has been taken care of by strengthening of the local currency. The RBI is targeting 4 per cent inflation on a durable basis with a 2 percentage-point band on either side. 

Inflation apart, what has happened between the last policy and now, to warrant yet another rate cut? The economic activities continue to be weak with the index of industrial production (IIP) growth dipping 1.7 per cent in January from a 2.6 per cent rise in December, weighed down by lousy performance of manufacturing and electricity. 

In the February policy, the RBI revised its forecast for India’s economic growth in 2020 to 7.4 per cent from 7.6 per cent earlier. Will it cut it further?
Consumer demand is weakening both in rural and urban India and the investment scenario has turned from bad to worse. The heat maps run by some of the foreign brokerages, incorporating data of consumption of cement, steel, power to the sales of automobile and the movement of cargo and freight, among others, are showing not a slowdown but a near-collapse in the investment cycle. Initially, many believed that the liquidity crisis for the non-banking finance companies that started end-August 2019 was the villain of the piece (as credit lines were choked) but now it is evident that the problem is much deeper.

A dovish US Federal Reserve and the softening of global growth too will encourage the RBI to go for a cut. Barring three small pockets — Norway, Argentina and Turky — the entire world is staring at a loose monetary policy regime. The Norges Bank (the central bank of Norway) increased its key policy rate from 0.75 to 1 per cent recently, second rate hike since September, seeing the upturn in the oil-driven economy. There could be another rate hike by June. 

Argentina has sharply hiked its key benchmark interest rate to fight inflation and revive the country’s peso currency and Turkey’s central bank has tightened its monetary stance after the lira weakened.

The euro zone and neighbouring Sweden are mired in negative interest rates even after years of record stimulus and the inverted yield curve in the US — yield on the benchmark US 10-year treasury notes falling below three-month rates first time since 2007 — is being seen as a signal for a rate cut late 2019, if not a risk of recession.
Against this backdrop, there are three choices before the MPC:

  • A 25 bps rate cut with a dovish undertone. 
  • A 25 bps cut, accompanied by change in the stance, from neutral to accommodative.
  • A 50 bps cut with a change in stance.

Even though many are rooting for a 50 bps cut, I would bet on a 25 bps cut. If MPC wants to wait for more data, it may not change the stance but be dovish in tone. Why not 50 bps cut? The RBI can wait till June for a new government to be in place (the profile of the government will have a bearing on the Budget) and clarity on the monsoon, likely to be impacted by the El Nino weather phenomenon this year. 

If the stance is not changed, it may run the risk of losing its sanctity. The previous two rate hikes (in June and August 2018) took place when the stance was neutral; subsequently, it was made tight. In the last policy, the rate cut was accompanied by a netural stance. If the stance is not changed to accompany another cut, a dovish undertone can give the right guidance. The market has already priced in a 25 bps rate cut and it’s up to the RBI to signal more cuts are on the table, data supporting. A 50 bps cut may indicate that the RBI is done with the downward cycle.

All six MPC members are likely to be in favour of a 25 bps point cut; at least a couple of them could even pitch for a deeper cut. On changing the stance too, there may not be unanimity.

The first policy of the year will also outline the RBI’s take on India’s growth story. In the February policy, the RBI revised its forecast for India’s economic growth in 2020 to 7.4 per cent from 7.6 per cent earlier. Will it cut it further? Fitch Ratings has recently cut India’s growth forecast for 2020 to 6.8 per cent from 7 per cent; Japanese brokerage Nomura also says the likelihood of Indian economy’s growth dropping below 7 per cent in 2020 is very high.

In the first week of March, the nation’s Central Statistics Office cut its GDP growth forecast for 2018-19 to a five-year low of 7 per cent from 7.2 per cent projected earlier. Its estimate for the December quarter growth is 6.6 per cent, the slowest in five quarters. Das will seize the opportunity of low inflation and join the gang of dovish-pivoting global central bankers to address the growth pangs by cutting the policy rate now and again, if things don’t change.
The columnist, a consulting editor with Business Standard, is an author and an senior advisor to Jana Finance Bank Ltd. 
Twitter: @tamalbandyo

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