Why ration out rate cuts when slowdown is so sharp?

There are two key takeaways from the Indian central bank’s fourth bi-monthly monetary policy. One, the monetary policy making body of the Reserve Bank of India (RBI) has acknowledged a sharp slowdown in the economic growth in Asia’s third largest economy; and, two, the rate cutting cycle has not ended as yet; there will be more rates cuts over the next few months.

For the record, the RBI has yet again cut the policy rate – this time by 25 basis points (bps) to 5.15 per cent, its lowest since March 2010, as is continuing with its accommodative policy stance. With the latest round, the policy rate is pared by 135 bps in eight months, between first week of February and October. One bps is a hundredth of a percentage point.

The GDP growth projection has been cut sharply to 6.1 per cent. This is sharper than two recent cut in India’s growth projection by the Asian Development Bank (ADB) and S&P Global Ratings. While ADB has slashed its growth forecast for India for fiscal 2020 to 6.5 per cent from 7.2 per cent (which was pared to 7 per cent in July) the global rater has lowered India's GDP forecast to 6.3 per cent from 7.1 per cent projected earlier.

When did we last see a 80 bps cut in the growth estimate by the RBI in just two months? Not even in 2008-09 when large part of the world plunged into recession in the wake of the collapse of Lehman Brothers Holdings Inc. At the August meeting of the monetary policy committee (MPC), the real GDP growth estimate for 2019-20 was pared from 7 per cent in June to 6.9 per cent. Now, it is down to 6.1 per cent, lower than what ADB and S&P Global Ratings have estimated.

In August, for the first half of the current fiscal, the projection had been kept in the range of 5.8-6.6 per cent and, and, for the second half, 7.3-7.5 per cent – with risks somewhat tilted towards the downside. Now, it has been revised to 5.3 per cent in the first half of 2020 and 6.6-7.2 per cent range for the second half, with risks evenly balanced. 

For 2021, RBI’s growth projection for Indian economy is 7.2 per cent, in sync with ADB’s estimate and higher that S&P Global’ estimate of 7 per cent.

Illustration by Binay Sinha
The MPC has noted that the “negative output gap has widened further”. Shorn of technicalities, it means, there is a lot of slack in the system -- inflation is unlikely to pick up and growth slowdown has intensified. The policy statement says while the recent spate of government measures (such as cut in corporate tax) is likely to help strengthen private consumption and fuel investment, “the continuing slowdown warrants intensified efforts to restore the growth momentum”.  As inflation is expected to remain below the MPC’s target of 4 per cent with a +/- 2 per cent band, “there is policy space to address the growth concerns”.

Even though the MPC has revised the inflation projection marginally upwards to 3.4 per cent for the year, it is well with the RBI’s target and one has to keep in mind that the MPC’s mandate is “flexible” inflation targeting. 

So, between-the-line message from the monetary policy statement is crystal clear: There will be more rate cuts. How much? And, when do see the next rate cut? The September quarter GDP data will be released on 30 November, ahead of the MPC’s December meeting. If the growth figure slips below the June level of 5 per cent, six-year low, or even remains at the same level, the next rate cut could happen as early as two months down the line. And, since the MPC believes in rationing out the rate cuts, it could be 15 basis points to 5 per cent. Or sharper. The direction is clear while the pace of cut will depend on the incoming data – both growth and inflation.

The question is: When the central bank acknowledges the growth scare by cutting down its GDP estimate by as much as 80 bps within two months, why did it go for just 25 bps rate cut? Shouldn’t there be a deeper cut? 

Governor Shaktikanta Das can say he has cut the rate by 135 bps in eight months and how much more aggressive can the RBI be? Well, out of 135 bps rate cut, 50 bps cut actually a reversal of rate hike done by the previous regime when Urjit Patel was at the helm of India’s central bank. Looking back, the 50 bps rate hike (done in two phases in June and August 2018) was not called for. So, actually, there has been a 85 bps rate cut, including the latest round – not too much when growth is slowing at an alarming pace.

This is why the market has shrugged off the latest policy action. Bond yields rose and there was sell off in the equity market, with the bankex losing the most. With most banks linking their loan rates for retail and small business units to the RBI’s repo rate, the transmission will be much faster now. I wonder why Ravindra Dholaka was the lone voice among the six MPC members for a 40 bps rate cut. It would have been better, had the MPC gone for a deeper cut at this juncture when it is not embarrassed to acknowledge the sharp slowdown.

The writer, a consulting editor with Business Standard, is an author and senior adviser to Jana Small Finance Bank Ltd. His latest book is “HDFC Bank 2.0: From Dawn to Digital”.

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