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Last Updated : Aug 06, 2019 10:33 AM IST | Source: Moneycontrol.com

Monetary Policy | Rate cuts passé — the RBI must address ‘deflation’ in sentiment too

While a rate cut by itself will not solve sector specific issues, a rate cut along with the right communication and cues on liquidity could go a long way in boosting confidence given the current context.

Moneycontrol Contributor

Sachchidanand Shukla

Rate cuts are the flavour of the season. Most central banks are headed south when it comes to policy rates, with the most notable being the US Fed, which made a sharp about-turn with a 25-bps rate cut recently. The Reserve Bank of India’s Monetary Policy Committee too is expected to cut policy rates by 25bp in its third bi-monthly policy meeting for FY20 on August 7. The central bank has already cut rates by a cumulative 75bp during 2019 so far on account of weakening growth amidst subdued inflation.

The economic deceleration has intensified over the last few months and data broadly paints a picture of subdued demand, notably in private consumption — firms and households continue to hold back spending.


The fiscal impulse also remains weak. While the Centre’s spending is up two per cent in Q1FY20, the aggregate spending of 19 key states is up just 0.2%. This largely owes to tepid revenue growth which will continue to constrain the government’s ability to pump-prime the economy.

It is true that India is in the middle of a slowdown. Nevertheless, this is not a time for self-flagellation. Let us get the context right: India is now participating in a globally-synchronised growth moderation. Real Private Consumption in Emerging Markets has nearly halved. Retail sales in Emerging Markets have come to a standstill literally — near zero from the highs of 2018. Even in the United States, which has done relatively better, consumer purchases, or retail sales, fell 3.5% in H1 to their lowest six-month total since the first half of 2013, according to JD Power and Associates.

While there are enough data points including the most oft-cited one on drop in auto sales volumes, I would urge the RBI to look beyond numbers. It must address the ‘deflation’ in sentiment which is impacting the ‘willingness’ to spend and invest among households and entrepreneurs alike. There is a complete loss of confidence across the board that is striking.

We must recognise that ‘Optimism is the engine of capitalism’ and while one fully recognises that another 25 or 50 bps by itself will not solve sector specific issues such as in auto, real estate or banking, a rate cut along with the right communication and cues on liquidity could go a long way in boosting confidence given the current context.

In fact, the RBI governor in one of his recent speeches mentioned that “the central banks’ role is important, both during normal as well as crisis times. While mandates for the central banks broadly remain same during both the periods, weightage attached to competing objectives and the choice of policy instruments become crucial in the crisis periods. Second, communication by the central banks is very important that may be different in crisis times than in normal times. Not only it helps convey decisions in a more transparent way, it also signals the present and future policy stance of the central banks”.

The other important thing to note will be — transmission, which has been the bane thus far. The RBI has done a commendable job in keeping liquidity abundant, which could help quicken the transmission. However, a commitment on liquidity will iron out volatility in the transmission channels.

An important caveat here will be that savings rate has been declining and aggressive deposit rate cuts in the endeavour to prop growth will further hurt deposit accretion. The RBI had decided to constitute an Internal Working Group to review comprehensively the existing liquidity management framework and suggest measures to simplify the current liquidity management framework and clearly communicate the objectives, quantitative measures and toolkit of liquidity management. The group was expected to submit its report by mid-July. It will be interesting to see the recommendations and the way forward.

Sachchidanand Shukla is chief economist, M&M Group. Views are personal.
First Published on Aug 6, 2019 10:33 am