RBI policy review: Rate cut, adequate liquidity needed to support growth

The focus of the Monetary policy committee (MPC) in its June meeting will be squarely on countering the growth slowdown, with CPI inflation almost 1% below the 4% target. Over the last two meetings, the MPC has already reversed the tightening done last year, taking cognisance of the impact of slower global growth on domestic activity. This time around however, domestic growth drivers, particularly private consumption, are showing signs of sluggishness. Among other things, the credit squeeze from the NBFC sector is dragging down economic activity. Moreover, global growth concerns around falling level of trade have resurfaced following the re-escalation of US-China trade tensions.  

All signs point towards the growth slowdown, which started over the second half of the previous fiscal, extending at least into the first half of the current fiscal year, with GDP growth remaining well below 7 per cent. That in turn would translate into actual growth falling below potential, curbing core inflation further. Core inflation has already seen a particularly sharp decline since October 2018 from 6.2 per cent to 4.5 per cent in April 2019, signalling loss of growth momentum. While food price inflation has started to move up, it is largely in line with the seasonal hardening seen in food prices ahead of monsoons.  Deficient monsoon is a risk to food inflation, but headline inflation is likely to remain below the 4 per cent target until November 2019 at least and core inflation could stabilize between 4-4.5% over the year. Considering these developments, the case for monetary easing is therefore a strong one.

The base case scenario would be another 25 bps cut in the Repo rate. Equally important will be the guidance on the future path of policy rates communicated through the policy stance. That in turn is dependent upon the forecasts for growth and inflation over the year and the assessment of balance of risks to those forecasts. In all likelihood the stance would be changed to "accommodative" from Neutral to signal a dovish shift, as downside risks to growth remain strong. It would also signal more monetary easing in future. 

Along with lower rates, guidance on systemic liquidity conditions will be crucial, as the pace of transmission of policy rates depends to a large extent on the level of liquidity. 

With the pace of deposit growth lagging behind that of bank credit and with persistence of tighter liquidity conditions, delays in the downward adjustment in lending and market rates is quiet likely. Therefore, active liquidity infusion is as important at this stage to support growth. Considering the inflation and growth dynamics, there is scope for at least 50 bps cut in the Repo rate, including the June rate cut. Any more easing beyond that would also be dependent on how the risks to inflation from monsoons, food price stabilisation, oil prices and fiscal deficit evolve. In the meantime, the RBI would have to ensure that monetary transmission lags are curbed by provision of adequate systemic liquidity.

(The author is the chief economist of IndusInd Bank. Views are personal.)