RBI should not cut its policy interest rate any further, says IMF

Supports govt and Reserve Bank's plans for gradually opening up the economy to foreign investors

The Reserve Bank of India (RBI) should not cut its policy interest rate any further, the International Monetary Fund (IMF) has said. It should, instead, keep the powder dry to fight an unexpected financial market turmoil that may hit after June this year if the US and China don’t reach a long-term trade agreement, it warned.

The IMF, though, is impressed with the way the countries in the region, including India, fought the financial markets uncertainties last year when the currencies witnessed depreciation pressure because of oil price rise, and the US Fed normalisation. That risk, according to Changyong Rhee, director of the IMF’s Asia and Pacific Department, is much reduced now.

“What we are worrying about now are two things — if there is no agreement reached on contrary to the market expectations, markets can react quite negatively, because they have already factored in some agreements to be reached. And if the tariffs are really increased, then the trade volume can significantly go down. That’s a scenario that we are worried about,” said Rhee at the press briefing of the Asia-Pacific region.

Even as the current environment allows more policy space to enhance growth and financial stability, the downside risk still remains and is higher now, the IMF warned.

“There are lots of uncertainties… whether the deal (on the US-China trade) will be reached or not. And then also, the global economy is slowing down. Given these uncertainties, I think it is still important for Asian policymakers not to be complacent, and look at how the things will go and try to save the ammunition in general,” Rhee said, even as he took comfort in the fact that if the downside risks materialise, “they have space to react”.

India, in particular, should exercise a pause, given that there have been two cuts already after the government missed fiscal consolidation targets yet again in the interim Budget.

“We think the two cuts were appropriate. But at this stage, together with the fiscal stimulus, we think that room for monetary policy easing has probably been exhausted,” said Anne-Marie Gulde-Wolf, deputy director of the Asia and Pacific Department at IMF.

“You have to see it all in a macroeconomic and global context. As we stand right now, the room (for cuts) has been exhausted,” said Gulde-Wolf.

The six-member monetary policy committee headed by newly appointed Governor Shaktikanta Das executed two back-to-back repo rate cuts of 25 basis points each to bring down the policy repo rate to 6 per cent, citing growth concerns. The bond market in India expects at least one more rate cut this year. But the IMF’s warning could prolong the waiting period.

Overall, the IMF sees Asia growing at 5.4 per cent in 2019 and 2020, though with increased downside risks. India is expected to grow at 7.3 per cent in 2019 and then at 7.5 per cent in 2020, slightly lower than projected in October 2018.

“In India, a slower pace of fiscal consolidation than previously envisaged, together with monetary easing, should support growth,” Rhee said in his opening remarks, adding, “India remains globally the fastest growing large economy”.

Capital account convertibility

The IMF officials endorsed India’s stance on gradual liberalisation of the capital account. At 70 per cent, India’s debt to GDP ratio is much higher than the 40 per cent level that would be required to open up space fully for the foreign investors, according to Gulde-Wolf.

“We will support a continued, gradual liberalisation of India’s capital account, broadly in line with the plans of the government and the RBI. This strategy needs to be well balanced considering the emerging external vulnerabilities that are around and taking into account the very high financing needs of the government. When looking at the capital account liberalisation, we would encourage looking at FDI (foreign direct investment). This should be a priority and then gradual opening in for portfolio flows afterwards,” Gulde-Wolf said at the press conference.

These are the same considerations for full convertibility of the Indian rupee, she said. The rupee is convertible on the current account, but not on the capital account. This means rupee cannot be freely converted into a foreign currency, and vice versa beyond a certain limit and purpose.

“The government has a medium-term fiscal strategy that looks at limiting debt at 40 per cent, once you are at that level and sustainability is achieved, then that would be the right time to consider the full opening of the capital account,” said Gulde-Wolf.