RBI policy: A cut in rate was expected; a cut in GDP growth target was not

The cut in GDP projection for FY20 is curious because it is also an admission that these 135 bps cuts in interest rates will not have a major impact on growth this year

It was widely expected that the Reserve Bank of India (RBI) would cut interest rates on Friday for two reasons. The first is that by now it has become a habit where low growth tendencies, which have taken precedence over the original goal of inflation targeting gets thumbs-up for a rate cut. The second is that over the last month or so, the government has announced various steps to revive the economy with the last measure being the corporate tax cut. A rate cut after all these announcements appeared to be a foregone decision. 

The point of interest, however, was the quantum of the cut. The last time the Governor went in for 35 basis point (bps) cut, which was non-conventional and had popped up the choice between 25 bps and something more this time around. The RBI has settled for 25 bps this time. 

Given that the 110 bps rate cut so far has not quite led to the uptick in investment, one can look upon the series of rate cuts as being work in progress to lower the cost of capital gradually over time so that when the investment cycle looks to pick up, potential investors would be comfortable with the rate regime. Also, given that there is a lot of hope being placed on the second half story working out where consumption picks up in both rural and urban sectors, a rate cut would provide an incentive to consumers to spend with support from finance. 

The recent trends in pick-up in ecommerce sales this season is encouraging and significantly has been supported by the equated monthly instalment (EMI) route, which would be given a thrust by lower interest rates. 

For banks, however, this rate cut should have ideally been factored in when fixing the external benchmark on October 1, as the new system is now in operation where a significant part of the loans (around one-third of total) is being priced at this benchmark rate. 

The GDP shocker

The other numbers that are on the radar in any policy are the gross domestic product (GDP) growth estimate as well as consumer price inflation (CPI). The RBI remains positive about inflation as the forecasts have been placed in the 3.5-3.7 per cent range for the second half. 

The fact that the government has already announced an unchanged borrowing programme for the second half (H2) is an assurance that fiscal pressures will not be generated. The category of food prices can be dodgy, but the RBI does not expect much of a disturbance in the months to come with core inflation remaining benign. 

The major announcement is the forecast of GDP growth, which has been reduced sharply to 6.1% with Q2 growth to be at 5.3% and H2 at 6.6-7.2%. This is an aggressive stance which implicitly assumes that there will not be much pick-up in the remaining months notwithstanding a good kharif crop and increased interest in consumption spending which is in evidence in the last few days. More importantly, investment would be stagnant, which is curious because it is also an admission that these 135 bps cut in interest rates will not have a major impact on growth this year.

Madan Sabnavis is chief economist at CARE Ratings. Views are personal