Monetary Policy: After ECB, RBI Sings The ‘As Long As It Takes’ TuneBloombergQuintOpinion
The release of the dismal gross domestic product growth print for Q1FY20 at a twenty-five quarter low of 5.0 percent had not only cemented market expectations of continued monetary policy accommodation, but it also led few participants to expect deeper cuts from the Reserve Bank of India after preempting a sizeable downward revision to the central bank’s growth forecast.
To be sure, the RBI did slash its FY20 GDP growth forecast by a massive 80 basis points to 6.1 percent, marking the sharpest downward revision within an interval of two months. If the time-span is extended to eight months, then one should also note that RBI’s FY20 GDP growth forecast has seen an even greater cumulative downward revision of 130 basis points since the February policy review, during which the FY20 growth forecast got introduced.
Given such outsized downward revisions to growth prospects, coupled with the four-quarter ahead-average Consumer Price Index inflation projection lying between 3.3-3.6 percent for the last five policy reviews, the policy response of a 25-basis point cut seems somewhat underwhelming.
The MPC had surprisingly opted for a larger dose of a rate cut (35 basis point) in the previous policy review in August, at a time when the central bank expected FY20 GDP growth to post a mild acceleration to 6.9 percent from 6.8 percent in FY19. Then, in the last two months, systemically-important central banks (like the U.S. Fed, European Central Bank, Reserve Bank of Australia, and Reserve Bank of New Zealand) have turned further dovish with a continuation of rate cuts and/or re-introduction of quantitative easing.
Why Only 25 Basis Points?
Three factors are likely to have guided a calibrated response from the MPC.
1. Fiscal Measures
The recent series of steps taken by the government to revive growth have two-fold implications for monetary policy. One, it provides policy complementarity for reviving growth conditions.
Since it attempts to create a positive fiscal impulse, this per se obviates the need for aggressive monetary policy easing.
Two, any concomitant fiscal slippage risk needs to be monitored as it can have potential implications for the credit market.
2. Food Prices
The latest surveys indicate that the inflation expectation of households increased by 20-40 basis points over the three-month to one-year horizon, which possibly is a reflection of the recent build-up in food prices.
3. Waiting For Transmission
The monetary transmission has been sub-optimal so far. Against the cumulative repo rate reduction of 110 basis points between February and August, the weighted average lending rate on fresh rupee loans declined by 29 basis points while the WALR on outstanding rupee loans increased by 7 basis points during the same period. This, despite systemic liquidity remaining in a comfortable surplus since June. The RBI would clearly prefer to see improvement in policy transmission after the cumulative rate reduction of 135 basis points between February and October.
“As Long As It Takes”
Despite the calibrated response, it is critical to note that the forward guidance of MPC now has elements of ‘unboundedness’ attached to its monetary policy stance. Drawing from the recent experience of the European Central Bank to “do whatever it takes” and “as long as it takes” to revive the economy, the RBI’s MPC now intends to preserve its accommodative stance until recovery in growth takes a credible turn.
This leaves the door open for incremental rate cuts in the upcoming months.
With the economy’s negative output gap being wider than previously anticipated, it is important to continue with a coordinated policy response, which traverses the divides of micro and macro on one hand and supply and demand on the other. In this context, fiscal policy has been playing an active role via demand (cash transfer scheme), micro (targeted measures for auto, MSMEs, and exporters), and supply-side (substantial cut in corporate tax rate) measures. However, with the current economic slowdown being predominantly consumption-led, there is scope for the RBI to top up its demand-side support with an additional 25-40 basis point rate cut in remaining part of the fiscal.
Shubhada Rao is Group President and Chief Economist at Yes Bank.
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.