RBI does its bit for growth: Sajjid Z Chinoy

The monetary policy report points to the risk of long drawn global stagnation that we should be concerned about

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Prima facie, the Reserve Bank of India (RBI)'s 50 basis points (bps) cut came as a pleasant surprise to markets. July inflation had undoubtedly surprised to the downside and with a Fed lift-off being pushed out, some space for easing had opened up. But since the August review, the monsoon deficit has widened from four per cent to 14 per cent and sub-normal water reservoir levels have raised concerns about the Rabi crop. And, with commodity and oil prices in rupee terms flat-lining over the last two months, markets had braced themselves for one final 25 bps cut.

So what underpinned the more aggressive action? First, the central bank clearly appears more concerned about global growth developments - and particularly those in other emerging markets - and the feedback to India.

In fact, the monetary policy report pointed to the risk of "long drawn global stagnation that we should be concerned about." Add to the external woes, the travails of the rural economy - which are likely to be compounded by another weak monsoon - and it's understandable why RBI marked down its growth forecast. Furthermore, prospects of weaker global growth would suggest the central bank has more conviction that the regime of benign commodity prices would sustain. These were likely key underpinnings of the more aggressive cut.

In addition, RBI appears more confident that food disinflation is likely to endure on the back of both pre-emptive and reactive government actions on food supply management, including the restraint shown on minimum support prices (MSPs). While benign global food prices have clearly helped, the government deserves enormous credit for containing food inflation despite a second successive monsoon deficiency.

That said, the job is only half done, and authorities will have to be on their toes in coming months, especially if the Rabi crop is also affected. Finally, RBI's desire to "front-load" monetary easing was also likely motivated by its desire to see greater transmission in wholesale and bank lending rates. The combination of the larger-than-expected cut, opening limits for foreign investors in the bond market, and the immediate announcement by the government that it would review administered interest rates on small savings schemes suggests a coordinated push to bolster monetary transmission. And the push bore immediate fruit with the State Bank of India cutting base rates by 40 bps a few hours after the RBI cut. Markets are likely to interpret the more aggressive cut as a sign that there is more to come. I'm not so sure. Disinflating the economy to five per cent in a year and four per cent in two years will not be trivial, especially when domestic growth begins to gather some steam or the global disinflationary tailwinds abate. So there may not be too much more monetary space. And the growth baton will have to pass back to the government to ensure the weight of structural reform more than offset global growth headwinds.

Sajjid Z Chinoy
Chief India economist, JPMorgan