Higher Real Rates Affect Economic Growth, Says Bank of America Securities

Real rates remain high, affecting growth, and timely liquidity is key to reduce lending rates, according to Bank of America Securities.

While the marginal cost of funds-based lending rates is falling in nominal terms, it’s rising in real terms, said Indranil Sen Gupta, India economist at the investment bank. “Even across the longer term, real lending rates have risen from 5 percent on an average before 2014, to about 14 percent after that, causing growth to slow,” he told BloombergQuint in an interview.

Despite a turn in several factors such as rate cuts by the Monetary Policy Committee, excess liquidity, recapitalisation of state-run banks, removal of banks from the Prompt Corrective Action framework and bank mergers, we saw growth tumble more than initially expected because of the real lending rate shock, Gupta said.

“In the current monetary easing cycle, the nominal MCLR has fallen by 45 bps because of Reserve Bank of India’s easing while real MCLR has gone up by 125 bps since March, because core WPI (wholesale price index)—which measures pricing power—has fallen by almost 160 bps due to falling commodity prices,” Gupta said.

Since real rates matter more than nominal, that has led to growth tumbling, Gupta said. The BofA India Activity Index, which had gone into a freefall, appears to have bottomed out in September and is now seeing a recovery in October, said Gupta. This quarter should give a further confirmation that growth is bottoming, he said.

The U.S.- China trade tensions and its impact on global growth, external benchmark and RBI rates, NBFC stress and spillovers also add to growth uncertainties, he cautioned.

Gupta, in a report co-authored by Astha Gidwani, India economist at the investment bank, expect retail inflation to peak in December, paving the way for a rate cut in February 2020. Inflation may peak in December at 6-6.5 percent depending on how fast onion prices come down, the report said.

The MPC would then have a choice. It can cut rates in February during the busy season and bring down lending rates further for small and medium-sized businesses, giving growth a fillip, they said. “Else, it could choose to wait for real policy rates to turn positive, in which case a rate cut will only happen in April or even later.”

Given that so much is driven by onion prices, the MPC will cut rates in its next meeting and then pause depending on global growth trajectory, according to the report. They expect the RBI to cut rates to 4.9 percent by March next year.

Fiscal Deficit Likely At 3.8%

The cut in corporate taxes will push the Centre’s fiscal deficit to 3.8 percent of the GDP, 50 basis points above target, BofA Securities estimates. Next year, the fiscal deficit is likely to be at 3.5 percent of the GDP, Gupta said, though it’s unlikely to impact inflation as growth is well below potential.

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