Another 25bps rate cut likely in August policy meeting; transmission is the key

With the fiscal space casting its shadow, the transmission will remain challenging. With another 25 bps cut in August, RBI will have cut rates by 100 bps.

The Reserve Bank of India’s monetary policy committee (MPC) will be meeting for the August policy in the backdrop of weak domestic growth, adequate comfort on the inflation trajectory, and prospects of easier global monetary policies.

The overarching concern is likely to be the domestic growth, with MPC members weighing the option of the extent of support needed for the economy, possibly through a mix of monetary and fiscal measures.

However, the RBI, having reduced repo rate by 75 bps and changing the stance to “accommodative”, will likely reduce it by a further 25 bps in the August policy.

The other issue that needs to be debated is the efficacy of the cuts, given the low transmission to bank rates. The markets have been waiting for an update on the liquidity management framework.

Certainty on the liquidity conditions, in accordance with the monetary policy stance, could assist in better transmission of the policy.

Since the last policy meeting in June, high-frequency indicators have signaled a sharper decline in the activity. Particularly, a slowdown in the automobiles sector along with weakness in cement production, fuel consumption, non-oil imports, etc. will weigh on MPC’s discussions.

We believe that the slowdown is more structural than cyclical, with the genesis of the weakness starting from an adverse mix of slowing household savings and increasing consumption over the past few years.

With savings reduction possibly reaching a trough, this mix had to correct, especially as income growth has been weak. A structural slowdown requires a mix of fiscal and monetary stimulus.

In the absence of adequate fiscal space (without significant slippages), much of the support is being expected of the monetary policy.

However, the MPC will also need to discuss ways to improve the efficacy of the rate cuts. Historically, there has always been an incomplete transmission of rate cuts to bank rates.

In the current scenario, with the fiscal space casting its shadow, the transmission will remain challenging. With another 25 bps cut in August, the RBI will have cut rates by 100 bps.

On the global front, growth remains under pressure and central banks have been indicating easier monetary policies, the US-China trade war continues to simmer, Brexit uncertainty is high, and crude prices outlook remains benign.Finally, the RBI’s inflation estimates of 3-3.1 percent in 1HFY20 and 3.4-3.7 percent in 2HFY20 are unlikely to be breached by a significant margin.

Further, core inflation has steadily softened over the past few months and will likely remain subdued given the weak aggregate demand scenario—indicating a widening of the output gap. The monsoon, which had a weak start, has been picking up.

A gradual upward-trending food inflation path has been matched by a declining core inflation path—increasing the scope for MPC to address the more immediate concern of growth slowdown.

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