RBI likely to cut rate by 25-35 basis points: Deutsche Bank's Kaushik Das

Real GDP growth has averaged 4.8% YoY in 1HFY20, as against India's potential growth rate of about 6.5-7%

India’s July-September real GDP growth slowed sharply to 4.5 per cent year-on year (YoY) (vs. 5.0 per cent YoY in April-June), in line with our estimate. While a weak GDP print was expected, as already indicated by the trend of various high frequency growth indicators, the slowdown in nominal GDP growth to 6.1 per cent YoY in July-September (from already a weak 8.0 per cent YoY outturn in April-June) was particularly striking. After all, nominal GDP growth matters more for corporate sector profitability and deficit-debt dynamic. GDP deflator moderated to 1.5 per cent YoY in July-Sep, from 3.0 per cent YoY in April-June, led by exceptionally low WPI inflation during the quarter (0.9 per cent average).

Real GDP growth has averaged 4.8 per cent YoY in 1HFY20, as against India’s potential growth rate of about 6.5-7 per cent. While growth may have bottomed in July-September, the recovery is expected to remain shallow in the quarters ahead, despite a positive base effect. Core sector data recorded a 5.8 per cent YoY decline in October (though partly due to Diwali holiday related distortions) and even with some improvement in November-December, industrial sector activity is likely to remain muted. We expect October-December real GDP growth to be slightly below 5 per cent, thereafter rising to 5.5 per cent YoY in January-March. According to our forecast, real GDP growth will likely average about 5.2 per cent in 2HFY20, which should lead to a full-year growth of 5 per cent in FY20. 

RBI’s projection for July-September growth was 5.3 per cent YoY and 6.6-7.2 per cent YoY for 2HFY20, leading to a full-year growth estimate of 6.1 per cent for FY20. These forecasts will surely be revised downwards, probably somewhere between 5-5.5 per cent, and the Monetary Policy Committee (MPC) will likely acknowledge that the growth recovery in the coming quarters is also expected to be shallow. We have a growth forecast of 6.2per cent YoY for FY21, but even then output gap will likely remain negative for most of next year.

While it will take time to sort out the non-banking financial companies (NBFC) sector issues, and with little space to provide support from the fiscal front (without breaching the fiscal deficit target materially, which can have negative consequences as far as ratings outlook and debt dynamics are concerned), the onus will likely fall on the monetary authorities to support growth, by reducing interest rates further. While CPI inflation has moved to 4.6 per cent YoY in October and probably will rise a bit more in November, due to higher food prices, it will likely come back to the 4 per cent mark by March-April of next year. The RBI will probably increase its inflation forecast (3.5-3.7 per cent range) by about 70-80bps for 2HFY20, but will also acknowledge the drop in core CPI inflation to 3.5 per cent in October (3.2 per cent without gold) and a particularly weak GDP deflator (1.5 per cent YoY in July-September).

Given the current weak GDP data (80bps lower than RBI’s forecast), we expect RBI to cut the policy repo rate by 25 bps on  December 5, though we do not rule out the possibility of a larger cut of 35 bps. Based on a simple Taylor Rule formula, we forecast the terminal repo rate to be 4.5 per cent in this cycle, which implies another 65 bps additional rate cuts to be delivered over the next few policy meetings.

Views are personal