Monetary Policy | In Charts: Deepening Slowdown Sets The Stage For Yet Another Rate Cut

Photographer: Dhiraj Singh/Bloomberg

With growth weakening and inflation under control, India's monetary policy committee is widely expected to cut interest rates for a fourth time this year.

Almost all of the 36 economists polled by Bloomberg forecast a 25-basis-point cut when the committee delivers its decision on Wednesday. This would take the benchmark repo rate down to 5.50 percent ⁠— the lowest in nearly a decade. The 100 basis points in rate cuts announced this year also marks the steepest reduction in interest rates in recent years, with the exception of the period following the global financial crisis.

The likely rate cut on Wednesday may not be the last in the cycle. Economists see rates coming down further with some predicting a fall in the repo rate to 5 percent.

The Reserve Bank of India has already cut the repo rate by 75 basis points. We expect 75 basis points of additional rate cuts (previous forecast: 50 basis points), spread over August, Q4 2019 and Q1 2020, taking the repo rate to 5 percent by March 2020. We also expect the RBI to maintain liquidity at a surplus.

Pranjul Bhandari, Chief Economist, HSBC Securities and Capital Markets

Stemming The Growth Weakness

The calls for more interest rate cuts come amid continued weakness in high frequency indicators. In particular, the auto sector has seen a persistent contraction in sales, leading to job cuts across manufacturing companies and dealerships.

Such indicators have prompted a cut in growth projections for the April-June quarter and the full financial year 2019-20. Should economic growth weaken further, the output gap ⁠— which reflects actual output in relation to potential output ⁠— would widen, allowing for more interest rate cuts.

We are now expecting the GDP growth to slow down even further from 5.8 percent in Q4 of FY19 to 5.6 percent in Q1 FY20. Our primary estimate suggests that GDP growth will be closer to 6.5 percent in FY20.

Soumya Kanti Ghosh, Chief Economist, State Bank of India

However, a number of economists are coming around to the view that India's growth slowdown is partly structural driven by weak income growth and falling savings. Interest rate cuts may do little to aid a recovery in that scenario but may help prevent further cyclical weakness, wrote Samiran Chakraborty, chief economist-India, at Citigroup Global Markets.

Inflation In Check

Should the MPC see the need for more interest rate cuts, the inflation outlook will not prove to be a hindrance.

At 3.18 percent, CPI inflation remains well below the mid-point of the MPC's target of 4 (+/- 2) percent. While inflation in the food and beverages category has risen in recent months, core inflation has fallen to 4.09 percent, reflecting weak consumer demand.

To be sure, the MPC will keep a close eye on the recent pick-up in food prices and the monsoons.

Rainfall in recent weeks improved, narrowing the deficit to about 9 percent until the end of July 2019, according to data from the IMD. However, the distribution of monsoon rains has not been encouraging, with foodgrain producing states such as Haryana, West Bengal and Gujarat facing a huge deficit, said Ghosh.

Liquidity In Surplus

Meanwhile, liquidity in the system has turned surplus since the MPC's last meet in June.

Markets will be watching for any guidance on whether the RBI is comfortable allowing such a large surplus to persist. A review of the liquidity framework is underway and will be crucial in determining the outlook for money market rates.

“With demand conditions muted, surplus liquidity is unlikely to have much impact on inflation in the near future. It could do good to the economy if the RBI provides some commitment on the extent of durability of the liquidity surplus conditions,” said Indranil Pan, chief economist at IDFC First Bank Economic Research, in a note.

Transmission Troubles

While easier liquidity conditions have helped improve transmission of lower interest rates, the pass-through of monetary policy changes remains incomplete.

The one- year MCLR for all banks stood at 8.6 percent in July against 8.8 percent in February, showed the RBI data. This 20-basis-point drop is much lower than the 75 basis points in repo rate cuts. In the bond markets, too, corporate credit spreads remain elevated.

Real interest rates are still quite high so, the effective impact of the headline easing is getting diluted, UBS said in a note. The high fiscal deficit and still constrained lending ability of public banks is impending the transmission and crowding out a private capex recovery, UBS said.

Amid the easing cycle, the MPC has seen a reshuffle after deputy governor Viral Acharya stepped down in July this year. The monetary policy portfolio is now being handled by BP Kanungo, who will be a part of the committee in August.