The effect of tax cuts has dissipated

Indices are below the 200-DMA - a reliable indicator of a long-term downtrend

The Reserve Bank of India (RBI) acted as expected by implementing its sixth successive rate cut and pulling the repurchase rate (or repo) down to 5.15 per cent. However, the market response was negative. The cut was discounted before it happened. Many investors feel that it doesn’t address the issue of soft demand.

The central bank also cut its forecast for 2019-20 which was, again, expected. Global growth is easing down. Gold prices are up on safe haven demand.  Crude prices are down upon slowing demand. Industrial commodity prices are also down. The dollar is stronger. Bond yields are down in Europe and Japan.

On the domestic front, private consumption expenditure is down, to an 18-quarter low.  Gross Fixed Capital Formation remains muted. A sharp reduction in imports has helped to contain the trade deficit and the current account deficit. This is again, an indicator of poor demand.

High-frequency indicators show that July-August was weak and more recent high-frequency indicators suggests that there’s no pick up in September as we head into the festive season.  Auto sales remained low in September and the PMIs for Manufacturing and Services are both low.

Among other sentiment indicators mentioned by the RBI, consumer confidence is low, manufacturing firms see a period of weakening demand and also expect input prices to soften. Transmission of the prior rate cuts is poor. Given a reduction of Repo of 110 basis points since February, commercial loan rates have declined 29 basis points.

Inflation is likely to remain muted, given that food production may have picked up and the monsoon has improved. GDP forecasts for 2019-20 are revised downwards by about 0.8 per cent, to an estimated 6.1 per cent. There are downside risks to this estimate since it assumes a sharp pick up in Q3, Q4.

The RBI has a credibility issue now. Monetary policy has failed to work. Three quarters worth of rate cuts have coincided with three quarters worth of successively weakening growth. It’s hard to imagine that another rate cut will lead to a sudden turnaround. The central bank’s oversight of PMC Bank has also failed to inspire much confidence as revelations have surfaced about the massive overexposure to HDIL.

Apart from inefficient transmission mechanisms, etc., there’s a simple reason why repeated rate cuts have failed to move the markets. That is, the overhang of government debt. Taken together, the states and centre need to raise about 10-11 per cent of the Gross Domestic Product (GDP) from bond markets, or in other forms of debt. The financial savings of households amount to less than that, at around 9 per cent of the GDP. The surplus of government debt demand over household savings means that rates can’t fall much.

The RBI statement was depressing. The central bank obviously doesn’t have remedies to turn around this situation. The issue here is partly one of sentiment. Given a slowing economy, consumers are cautious. The corporate tax cut announced last month by the Finance Minister will help to boost earnings for already profitable companies. But it doesn’t boost demand and that means it may not help to trigger growth spurts.

The second half estimates of 2019-20 are in the range of 6.6-7.2 per cent with an estimate of 7.2 per cent for April-June 2020. That would be partly based on the base effect since the comparison periods are all low-base. But it also implies that growth will rise by a solid 1.7-2.2 percentage points in the second-half.

The festive season, which has just started, is a key period if we are going to see this kind of growth acceleration. Every type of consumer-facing business is offering discounts and pushing products and services. There are new model launches of mobiles, and of cars, and of smart TVs, and of package tours. This could kickstart a period of higher consumption. It’s the best that investors can hope for, as a sort of festive gift.

As mentioned above, the market responded with a sell off to the monetary policy. The positive effect that arose from the announcement of the tax cuts has dissipated. Purely in technical terms, the Nifty and Sensex are now back below their respective 200-day moving averages (DMA), after a brief period when they shot above that level. A move below the 200 DMA is usually a reliable indicator of a long-term downtrend.