The widespread expectation is that the Monetary Policy Committee (MPC) will give
a 25 basis point cut. Almost everything else is a matter of debate. The confidence in a cut comes from the fact that last reading of inflation for February 2019 was at a benign 2.57 percent; Consumer Price Index (CPI) is not seen rising by December to even the 3.9 percent forecast by the Reserve Bank of India (RBI) in the last policy. As well as leading indicators like car sales and non-banking finance company (NBFC) loan growth show that the economy has slowed more than expected. For the moment growth needs more attention since inflation is unlikely to rise above the MPC’s target of 4 percent any time soon.
The consensus ends here. There are doubts on whether the MPC will change its stance from neutral to accommodative. For the markets, such a change in stance will indicate there are more cuts to come. This can push down bond yields and nudge banks to cut their lending rates. But then the RBI changed its stance from tightening to neutral in just the last policy. Will a majority of the MPC members want to change to an accommodative stance this quickly? It’s possible such a stance doesn’t get majority support.
A change in stance can be justified only if the RBI cuts its gross domestic product (GDP) expectations for the current year. The RBI’s GDP expectations stand at 7.2-7.4 percent for the first half of this year and at 7.5 percent for the third quarter. However, since early February global growth expectations have receded. International Monetary Fund’s (IMF),
Christine Lagarde has just said that she expects 70 percent of the countries to grow more slowly in 2019, versus 2018. Also, private weather forecaster Skymet has just predicted a less than normal monsoon. This means rural distress can get worse and hence rural demand can fall further. It is likely the RBI lowers the average growth for the current year to 7.2 percent from the current 7.4 percent. This may not sound pessimistic enough for a series of rate cuts.
The bigger issue for the economy is how far RBI goes to ensure rates are
transmitted by banks. This will depend on RBI’s stance on liquidity. Will the governor or the deputy governors indicate that they will move from the current neutral liquidity to surplus liquidity? In other words, currently, banks borrow around Rs 75,000-100,000 crore from the RBI on a daily basis to make up for their CRR (Cash Reserve Ratio) shortfalls. Will the RBI indicate that it is willing to move in so much liquidity that banks lend money to RBI as often as they borrow from it. The sheer worry that they may have excess liquidity on some days will force banks to offer more loans and cut rates on loans and deposits.
Of course, the RBI’s views on setting external benchmarks for bank lending rates may also be announced along with the policy. This too can help to transmit rate cuts. Besides bond dealers will want to watch if the RBI is showing any preference for increasing liquidity through dollar swaps rather than bond purchases. More dollar swaps can mean lesser demand for bonds.
Finally, what are the chances of a 50 basis point rate cut or a CRR cut? A 50 basis point cut looks unlikely first because a majority of the MPC members haven’t sounded so dovish so far. Even if the governor Shaktikanta Das and Dholakia, the two more dovish members, are convinced of a 50 basis points rate cut, swinging two of the other four looks tough. And the governor using his casting vote for a decision as momentous as a 50 bps cut is a huge ask. It can’t be justified when growth is expected to be over 7 percent, and India is frequently touted as the fastest growing large economy in the world.
On CRR, RBI’s argument so far has been that India’s CRR at 4 percent is just right, and a cut must be used in an emergency such as a major default in the debt market.There are two good reasons why the MPC members should resist going as far as a 50 basis points cut or a CRR cut. Firstly, the warning from the weatherman is ominous. There are large income transfers waiting to happen to the farm sector. A fall in farm output under such circumstances can quickly reverse food prices which can in turn reverse headline inflation too. After all non-food, non-fuel inflation is still as high as 5.3 percent. Secondly and more importantly, the fiscal math is still very unconvincing. Companies and chartered accountants complain that tax officials have made unreasonable demands to met targets and hence more refunds this year can’t be ruled out. Payment for some expenses have been pushed from the previous to the current year. All this is in addition to the government routing a large amount of its borrowing via public sector units like Food Corporation and PFC. Loose monetary policy at a time of fiscal laxity has not served us well in the past. The MPC must tread carefully. My base case would be for a 6-0 or a 5-1 vote for a 25 bps rate cut. The policy stance may also change to accommodative, but here the vote may be more 4-2.