Tulsi Jayakumar
The calendar year 2019 has witnessed much action on the monetary policy front. The policy repo rate has been cut four times in a row by 110 points this calendar year. At the same time, the monetary policy stance has moved from ‘calibrated tightening’ to neutral in February 2019, and from neutral to accommodative in June 2019. The fourth bi-monthly monetary policy review due on October 4, 2019 will very likely continue the rate cuts as well as the accommodative policy stance. In fact, we see the policy rate coming down in stages from 5.40 percent to 5.00 percent by the end of the year.
Domestic economic considerations will weigh predominantly in determining such a move. The August estimates for Gross Domestic Product (GDP) show a deep slowdown in the June quarter of FY 20, with real GDP growth at 5 percent and nominal GDP growth at 8 percent, the lowest since FY 2002-2003.
The slowdown has been largely led by a collapse in consumption growth which grew by only 3.1 percent. Consumption may weaken further, as noted by the RBI in its annual report, due to the delayed onset and skewed distribution of the south-west monsoon rainfall which may affect crop production and hence rural demand. The sharp contraction in sales of motorcycles and tractors in rural areas by 8.8 percent and 14.1 percent, respectively, during Q1FY20 already attests to weakening rural consumption demand. Urban demand has also been weak with both passenger car sales and domestic air passenger traffic registering contraction in recent months.
On the supply side, the slowdown was reflected in the dismal performance of the manufacturing as also construction sectors, which grew by a meagre 0.6 percent and 5.7 percent respectively in Q1FY20, compared to 12.1 and 9.6 percent in the same quarter of 2018-19. In terms of the use-based classification, the production of capital goods and consumer durable goods decelerated. The latter was on account of a reduction in auto (including two-wheelers) and white goods sales.
The negative prospects on the domestic growth front are unlikely to be mitigated through external sector growth. A slowdown in global growth in 2019, as per IMF estimates, from 3.6 percent in 2018 to 3.2 percent in 2019, poses downside risks. Escalation of trade tensions, geopolitical strife and renewed financial volatility in EMEs make India’s external sector particularly vulnerable.
Growth rate of both exports and imports have decelerated, with export growth rate falling from 10 percent in Q1 FY19 to 5.7 percent in Q1FY20 while import growth rate has fallen from 11 percent to 4.2 percent over the same period. The fall in exports indicates the challenges to growth from the global demand side.
In the case of imports, the fall has been due to a fall in both capital goods imports, as well as that of oil, indicative of the tepid consumption and weak demand. In fact, the risks to the import bill in the coming months is likely to be high given the uncertainty regarding international crude oil prices.
Even as India witnesses a slow-down, with several downside risks to growth both on the domestic and global front, the trajectory of headline inflation has remained benign, with CPI (General) at 3.21 percent for August 2019, lying below the medium-term target of 4 percent.
While the slowdown is now well-accepted, the moot question is: What is the nature of the slow-down? Is it cyclical or structural? Cyclical slowdowns will necessitate counter-cyclical responses- both from the monetary and fiscal fronts. It appears that the RBI, as also the government have arrived at a unanimous decision that the slowdown is a cyclical one, rather than a structural slowdown.
The past two months have witnessed a slew of fiscal measures aimed at reversing this slow down. In August, the Finance Minister announced a set of moves to prop up the slowing economy, including consumption demand through cheaper loans for homes, vehicles and consumption goods. In September, the government has announced corporate tax cuts to revive investment in the economy.
The RBI will now be expected to do its bit to complement the government’s efforts. Thus, against a backdrop of negative output gap and a benign headline inflation trajectory, growth concerns will be the main determinant of the Monetary Policy Committee decision.
Be prepared for an early Diwali gift- a rate cut bonanza, which likely will continue throughout the year.
Tulsi Jayakumar is Professor of Economics and Chairperson, Family Managed Business at S. P. Jain Institute of Management & Research, Mumbai. Views are personal.
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