The time is ripe for RBI to front-load rate cuts

This, because of weak economic growth momentum, benign CPI and govt's commitment to fiscal prudence

India’s growth outlook remains muted at this juncture. Even the government’s Economic Survey suggested the outlook for 2016-17 must be evaluated in the wake of the November 8 action of demonetisation. Economic growth was already pretty weak in the first half and slowed down further in the aftermath of demonetisation and the US election results, impacting its only two supporting drivers, consumption and services, due to their high-cash intensity. Recent corporate results showed that stresses have continued unabated for the steel, power and realty sectors. Many other industries (e.g. automobiles & textiles) holding firm until November, posted negative growth in net sales and profits in the third quarter. Consumer Price Index (CPI)-based inflation, too, has fallen significantly on crashing prices of foodgrain & perishables and moderation in core inflation as a result of the negative demand shock. It is certain now that CPI prints will remain benign until March and CPI will undershoot the Reserve Bank of India (RBI)’s target of five per cent.  

On the fiscal front, the Union Budget for 2017-18 was more conservative than expected and has acted more in favour of fiscal prudence by setting fiscal deficit target at 3.2 per cent of gross domestic product, a modest deviation from the road map’s three per cent but much lower than expected. The government’s net borrowings are also pegged at Rs 3.48 lakh crore — lower than the previous year, though this accounts for Rs 75,000 crore in buy-backs. This is one grey area for fixed income investors, as they have no clue as to when these buybacks will happen and when is the maturity. Another area of concern is the revenue expected from the small savings schemes. However, we must remember the government has not accounted for any revenue from the new income declaration scheme, which could be substantial. This, to some extent, could help the compensate for the possible loss of revenue from small savings.

Against the domestic backdrop of weakened economic growth momentum, benign CPI inflation and the Budget’s commitment to fiscal prudence, there is a high chance that the Reserve Bank of India may cut policy rates more aggressively on February 8. While RBI might weigh local factors against three emerging global risks — rising US Federal Reserve rates, changed direction of global crude oil prices and improved expectations of global outlook — in our opinion, it will attach higher weights to local factors than global ones, given the severity of domestic growth slowdown. Banks have already cut MCLRs after the Prime Minister’s speech on December 31. While ‘transmission’ has happened through the credit segments, it has not happened through the corporate bond market to the same extent. The costs of borrowings on long-tenor instruments still remain very high. Moreover, it is in the interest of the government to push bond yields down, as they would like to borrow long at a decent rate in 2017-18. 

Both the government and the private corporate sector will benefit if yields fall decently in the bond markets, and this may happen only if the RBI cuts the repo rate by 50 basis point in February by front-loading the policy rate cuts. This is like a last chance for the central monetary authority. Going forward, it will be difficult for RBI to cut rates aggressively, once the uncertainty related to next year’s monsoon sets in and global risks start acting as the limiting factors. 
 

The writer is group chief economist of L&T Financial Services