RBI policy: Fiscal could add a twist to monetary easing, says economist

As the RBI has de-emphasised the concept of real policy rates, forecasting the terminal rate has become more difficult, says Samiran Chakrabarty

In the October MPC meeting, the critical departure from the August policy is going to be the change in the growth outlook and the uncertainty around the impact of the corporate tax rate cut. While the former might prompt the MPC to consider a deeper rate cut, the latter could force the MPC to rethink the monetary policy path when the fiscal has come onboard to support the recovery.

We think that the RBI is more likely to push the FY20 GDP growth forecast closer to 6 per cent from 6.9 per cent earlier but have a sharply higher forecast for FY21, anticipating the fiscal and monetary stimulus to work through the system. On the other hand, the FY21 CPI forecast could be pegged at below 4 per cent, making the MPC worry less about inflation for the time being. Part of the food index and oil prices have been volatile but there are no signs of these getting generalised into more broad-based inflationary pressures. This growth-inflation combination tilts the scale towards promoting growth through countercyclical monetary policy.

To decide on the desired quantum of monetary easing, the MPC will have to make an assessment of the impact of the corporate tax cut on fiscal and growth. If the MPC considers the extent of fiscal stimulus to be large enough, then the pressure on monetary policy to do double-duty comes down. Based on this view, we think that a 25bps cut with guidance for further easing could be the likely outcome in the October MPC meeting. Given the supply side nature of this fiscal stimulus, the MPC might consider that there is no immediate risk of an inflation rebound. If the MPC downplays the impact of the fiscal action in the short run then the cut could be more than 25bps too, although we think it is less likely.

Samiran Chakrabarty, Chief economist, Citibank

As the RBI has de-emphasised the concept of real policy rates, forecasting the terminal rate has become more difficult, especially when all the nominal variables are deflating quite sharply. If the MPC is more reactive, then it is possible that it continues to ease policy as long as the “low growth – low inflation” scenario persists. This could imply substantial space of monetary easing till growth recovers close to the potential level. However, we think that going forward greater focus will be on transmission of past rate cuts. The 110bps rate cut has not yet translated completely into lower lending rates with the weighted average lending rates for fresh loans in fact inching up in July.

A more proactive MPC will also be cognisant of the lag with which monetary policy operates and will look out for the turning point in the economic cycle. In our view, we have not seen enough momentum in high frequency data to call for a turnaround yet and hence another Rs 50bps cut in this cycle is possible. Such an easing could take us closer to the terminal rate where the MPC could pause to reassess the impact of the cumulative 160 bps cut (110bps done + 50 bps expected).