Monetary policy review: RBI may cut rate, but commentary will be cautious

Economic and markets indicators are increasingly signaling a slowing economy, but an even greater worry is a weakness of both consumer and investment sentiment

A synchronised rate cutting cycle by central banks, across geographies in developed and now emerging markets, is the current global theme. Trade related uncertainties, slowing investment and weak sentiment is resulting in a steady growth deceleration, with a progressive weakening of sentiment reinforcing the slowdown. Inflation has remained steady and low, diffusing out from developed economies into the broader global economy.  We expect the MPC to again cut the repo rate, probably unanimously. 

Economic and markets indicators are increasingly signaling a slowing economy (the June 8 core sector flat print is the latest), but an even greater worry is a weakness of both consumer and investment sentiment. The underlying perception of risk seems to have changed, for reasons inter alia either of employment uncertainty or a fall in disposable, discretionary incomes. Consequently, consumption seems to be getting pushed back and the output gap is widening. However, a couple of current developments are likely to inject caution in the MPC commentary.  First, a hardening of the US-China trade negotiations and the immediate and future Chinese response, particularly the Renminbi exchange rate, will increase financial market volatility, risk off sentiment and likely result in a rupee depreciation.  Second, recent prints of forward looking economic surveys have begun to present somewhat inconsistent outlooks, with some indicating a forthcoming upturn, but others persisting with the current adverse assessment.  Given this uncertainty, an important input into the MPC statement of the likely path going forward, will be the responses to the surveys conducted both by RBI on household and business expectations, which will be known only post the MPC statement. Monetary policy will probably be data and event dependent, and will not commit to a pre-set path. An important aspect of the MPC communication on “forward guidance” will be (changes to) the RBI’s forecasts on growth and inflation. 

Saugata Bhattacharya

Growth forecast for FY20 may be slightly lowered from the earlier 7%. The CPI inflation forecast may be retained broadly at the earlier 3.0-3.1% for H1 FY20 and 3.4-3.7% for H2. 

Transmission of MPC repo rate cuts is now crucial for the monetary policy response function. The series of rate cuts, together with the current surplus liquidity and expected less tight conditions over the year, is likely to lead to a progressive reduction in the cost of funds for financial intermediaries, and thereafter for lending rates, particularly for banks. If higher credit flows are to complement other policy stimulus actions, the use of micro prudential levers, beyond those already proposed, to judiciously stimulate flows into sectors squeezed of funds will be needed. 

The author is Senior Vice President, Business and Economic Research at Axis Bank. 

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