Coronavirus: Rate cut to create only asset bubbles, not to lift demand: Report

Days after the US Fed sharply cut interest rates by 50 bps in one single stroke to help fight the coronavirus, SBI economists have warned against any such action by the RBI, saying slashing interest in an economy facing a severe demand slump will only create fresh asset bubbles.

The coronavirus outbreak has been roiling the global markets since the middle of the past month and has spread to over 84 countries now, massively disrupting the global supply-chains and trade and commerce. The World Bank has warned of an impact to global trade to the tune of around USD 350 billion.

"A rate cut by the Reserve Bank in current domestic context will only lead to asset bubble and possibly no correction in demand," SBI Research warned in a note.

This is because, they argue that "there is also an embedded adverse supply shock angle as China is the supplier of many critical inputs in the global supply chain of manufacturing. In this respect (a possible) pandemic shock is not comparable to other types of crisis," it said.

The economy has been on a downward spiral for the over 18 months now and has hit an 11-year low at 4.7 per cent in the December quarter. Almost all analysts primarily blame the slumping demand for the low growth numbers.

The dichotomy of protecting the so-called "wealth effect" and become accommodative to growth, poses a huge challenge to the central banks in developed markets and hence coordinated rate cuts, the report notes.

But in the domestic context, this does not suit given the low share of retail investor participation as proportion to total investors.

"The share of retail investor participation as proportion to total investors is only 11 per cent in the country while the same is close to 50 per cent in the US, 42 per cent in Italy and 20 per cent in Singapore.

"Given this, to fight the Covid-19 outbreak, conventional monetary policy like rate cuts might be the second best option and the first best option is to maintain a proactive liquidity regime and facilitating stability in financial markets through unconventional measures," they said.

The report rather says the arguments favouring RBI cutting rates have more to do with coordinated policy actions by the central banks, as "with inflation unlikely to move materially below 6 per cent till Juneand the real policy rate being the lowest in the country being negative after Poland, talks of a premature RBI rate cut gaining precedence is surprising.

This apart, coordinated monetary policy actions though sound good but exits are always not coordinated and thus causes market disruptions.

On a positive note, the report says supply chain disruption has created clear opportunities for sectors such as textiles and pharma for the country. In pharma, the situation is an opportunity to increase domestic API production.

With global realisation of geographic concentration risk in API production in China, even with 3 per cent cost difference the Indian pharma will remain competitive.

Other sectors that can benefit are ceramics, homeware, fashion and lifestyle goods, textiles, engineering goods, furniture, chemicals, engineering goods and marine products.

Also, the falling crude prices can benefit the country more as everyUSD 1 increase in a barrel of crude leads to a 2 bps impact on inflation while in every USD 1 fall in crude there is a 3 bps impact.

There is no doubt that financial markets now ascribe significant disruptive potential to Covid-19, and those risks are real. But the variations in asset valuations underline the significant uncertainty surrounding this epidemic, and history cautions us against drawing a straight line between financial market sell-offs and the real economy, concludes the report.