Time to shift towards growth as fiscal policy space remains limited

Between the April and June Reserve Bank of India (RBI) monetary policy committee (MPC) meetings, the global and domestic backdrop has softened materially. Global growth outlook has weakened with renewed trade tensions. India’s fourth quarter 2018-19 gross domestic product (GDP) growth has come at a five-year low, corroborating the trends from high frequency indicators, while inflation parameters have broadly remained within the projection made by the RBI in April. In our view, the monetary policy bias could shift more towards growth in this context, as the fiscal policy space remains limited.

Acknowledging the softness in high frequency growth indicators, the RBI revised down its 2019-20 GDP growth forecast by 20 basis points (bps) to 7.2 per cent in the April policy. It might have to do it again in June, particularly for the first half where it was pencilling in 6.8–7.1 per cent growth. There is not much urgency in revising the consumer price index (CPI) forecast though, as the upside risk from higher food inflation is likely to be balanced by the lower-than-anticipated momentum in core inflation.

With a distinct positive output gap opening up from the RBI’s potential growth estimate, we believe that a consecutive third 25-bps rate cut is warranted. Real policy rate at 200 bps (based on one-year-ahead CPI projection) is on the higher side and rate cuts could be justified from that standpoint too. The discussion on considering more than 25-bps rate cut in June could also be on the table. But given the volatile macro backdrop and the ‘neutral’ monetary policy stance, that option might not be favoured. Also, the possibility of another rate cut in August has now opened up, which will be contingent on the progress of monsoon and the Budget math.

The forward guidance from the monetary policy stance has been less impactful, as it has not been able to provide a consistent framework in a rapidly evolving macro environment. The MPC might be tempted to shift to an ‘accommodative’ stance if it wants to indicate dovishness in excess of the 25 bps cut. But it might be difficult for it to do it at a time when there is not much visibility over rate cuts beyond the June policy.

A combination of RBI policies (open market operations and foreign exchange swaps), positive balance of payments, and reduced pace of currency demand has ensured the banking system liquidity has improved substantially from the April tightness.

An assurance from the RBI that the liquidity will be maintained around current levels would be welcome, but markets will have to appreciate that it is difficult for the RBI to keep the system in large surplus under the current monetary policy operating framework of ensuring weighted average call rate to stay close to the repo rate set by the MPC.

The transmission of the last two rate cuts has been at best partial. Providing proactive liquidity comfort is a good start for better transmission. All eyes would be on whether the June MPC provides some more relief.

The author is Chief India Economist, Citibank. Views expressed are personal