Room for rate cuts, not fiscal expansion, says RBI governor Shaktikanta Das

He was not willing to comment about the potential real interest rate of India that the central bank should fixate upon as the MPC cannot pursue multiple targets

Reserve Bank of India (RBI) Governor Shaktikanta Das said there was space for rate cuts even as the government had little room for any fiscal expansion and the inflation is well below the mandated level. The Monetary Policy Committee (MPC) is due to announce its policy decision on October 4. Analysts expect 

25-40 basis points cut in the policy.

The governor, however, was not willing to comment about the potential real interest rate of India that the central bank should fixate upon as the MPC cannot pursue multiple targets. 

The governor’s statements, on the sidelines of the Bloomberg India Economic Forum on Thursday evening, are important as the government tries to shore up the economy through various measures, but falls short of the market expectations, which clamour for more substantial packages. Economic growth has fallen sharply, surprising observers. The six-year low growth rate of 5 per cent was a surprise even for Das. The RBI had predicted growth at 5.8 per cent. “Nobody predicted less than 5.5 per cent. The number came as a surprise, worse than all predictions,” said the governor in an interview to CNBC TV 18 earlier 

this week.

“The policy objective of the MPC is to maintain price stability, keeping in mind the objective of growth. Today, when we see that price stability is maintained, and our inflation is well below 4 per cent and expected to be slow in the next 12-month horizon, there is room for a rate cut, especially when growth has slowed down,” said Das on Thursday. 

But the government might not be in a situation to give a fiscal push, the governor indicated.  However, he said the decision on this would be taken by the monetary policy committee when they meet in October. 

“Within the policy framework the MPC will consider these aspects as well as several other factors including the assessment of growth and inflation projections. The final decision will be taken in the ensuing MPC meetings in October 2019,” 

Das said. 

“Government’s fiscal space itself is quite limited. The fiscal deficit is at 3.3 per cent (of the GDP). There is a lot of talk about public sector borrowings by the government so both put together there is very little fiscal space for the government,” Das said. Whatever measures announced by the government don’t upset the fiscal math, according to the RBI governor. “The government has remained prudent as they have not announced any counter-cyclical measures in terms of fiscal expansion. They have taken some administrative measure with regards to automobile, export, and banking sectors. And most of these don’t have a fiscal pressure,” Das said.

In his speech, Das said rupee was fairly valued, even by standards laid out by the International Monetary Fund (IMF), which sees zero gap between the rupee’s exchange rate and the real effective exchange rate (REER, which measures the rupee’s relative strength against a basket of currencies).

“India’s exchange rate regime is flexible and market-driven, with the exchange rate being determined by the forces of demand and supply. The RBI has no target or band for the level of the exchange rate. Interventions are intended to manage undue volatility,” Das said in his speech, even as he concluded that heightened volatility in the exchange rate in the past two years has been because of global spillovers. Bond yields have been going up too because of external factors, and the universe of negative yielding bonds is growing disconcertingly large, posing a potential threat to financial stability,” he said in his speech.

The US Federal Reserve’s rate cut by 25 basis points would attract more capital in emerging markets such as India, even as the Saudi Arabia crisis would unlikely fan inflation in India, the governor said. But the volatile international crude prices continue to pose potential risks to the viability of the current account balance through trade and remittances channels. 

India’s macroeconomic fundamentals are strong, current account deficit is low, and the country is one of the least externally indebted countries in the world. The US-China trade war could be to the advantage of India. India’s demography would continue to favour the nation till 2055. 

“In this milieu, prudent external sector management with a close and continuous vigil on areas of external vulnerability assumes critical importance and will continue to receive RBI’s close attention,” he said.

The outlook for India’s external sector is one of cautious optimism, albeit with some downside risks accentuated at this juncture. “Among them, deepening of the global slowdown and escalation of trade and geopolitical tensions appear to be the most significant,” Das said. 

“The search for new export markets and new niches must go on so as to reap the benefits of changing dynamics of global value chains. Indian IT companies need to accelerate market diversification and invest in new skills and technologies to hone their comparative advantage.” 

Remittances and non-resident deposits are likely to remain shock-absorbers over the medium term and need to be assiduously cultivated, including by ease of remitting and reducing transaction costs, Das said. “Ultimately, the strength of the external sector derives from domestic macro-fundamentals. Investors and markets need to be credibly assured of our ability to maintain macroeconomic and financial stability through continued focus on these areas,” Das said.