Monetary policy: RBI to stay on course, says IDFC First Bank economist

Worse than expected GDP numbers of 5 per cent for Q1FY20 have jolted all, including the RBI. The government has swung into action with a variety of measures that tended to ease the flow of funds and also announced some sector specific measures for housing and auto. The latest move came in the form of corporate tax rate cut. However, this is seen to have longer term benefits in terms of improved competitiveness vis-à-vis rest of Asia while it still might not lead to immediate investment intentions by manufacturers, given the low visibility of demand. 

On the other hand, there is limited risk on the horizon for Headline CPI inflation to move beyond the 4 per cent threshold of the RBI. Food inflation will stay muted with monsoons ending on a positive note and kharif sowing recovering from the early season weakness. True that onion prices have been on the boil recently but this is mostly seasonal with inclement weather conditions reducing the supply of the crop. Further any production losses due to late rains can be made up from Centre’s buffer holdings and the government has also dis-incentivised exports by raising the minimum export prices. With private consumption expenditure growth remaining very slow, and with low levels of increases in rural and urban wages, core Headline CPI inflation has been on a downtrend. 

With limited fiscal space, especially after the corporate tax rate cut, RBI will have to do the policy heavy-lifting to try and push the economy out of the slump. There has been some commentary that indicated that the recent fiscal push will probably limit the room for the RBI to cut rates. We, however do not think so as we do not anticipate any immediate big spending from the corporates out of the saved taxes.  

With inflation remaining contained, RBI still has room for another 40 bps for Repo rate to go down. However, this whole dose cannot come together as from October 1 banks will have to link some parts of their lending activity to the repo rate and with the liability side of banks more inflexible in terms of costs, it might become difficult for banks to absorb this large shock. It cannot be as little as 15 bps, then the market will think that the RBI is precipitously close to the end of the cycle. We favour 25 bps cut in October and the remaining portion to come in December. Important to note that after 110 bps rate cuts already and with another 40 bps to go, RBI is no doubt reaching the end of its interest rate cutting cycle. For now, we prefer a terminal repo rate of around 5 per cent and hope that macro conditions remain suitable enough for the RBI to hold on to these levels for a longish period. 

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The columnist’s views are personal