Soumya Kanti Ghosh
As the MPC sits down to deliver its verdict on April 4, the most important question it needs to consider is: how weak are the growth impulses?
Global growth impulses look increasingly fragile. GDP growth in the Euro area is projected to remain soft in 2019 and 2020, particularly in Germany and Italy. Uncertainty persists about the timing of the UK’s withdrawal from the European Union and the nature of the UK-EU trading relationship in the short and medium-term. The increase in tariffs between the two economies because of WTO rules would reduce GDP by around 2 percent (relative to baseline) in the United Kingdom in the next two years. GDP growth in China is projected to moderate gradually to 6 percent by 2020.
A consensus is yet to emerge about when the US could slip into a slowdown following the yield curve inversion last week. There is an interesting relationship between the US inverted yield curve (i.e. 10-year G-sec yield minus 1-year yield) and a US recession. If we analyse the data since the 1950s, a recession in the US followed an inverted yield curve on every occasion but one. The average time between an inverted yield curve and the US economy slipping into recession is 14 months and the average duration of the recession is 12 months. By this logic, the US might plunge into a recession by the end of 2019 or early 2020.
Against this background, we expect domestic growth impulses could remain soft at least for the next two quarters. In particular, the investment scenario is weak, as can be inferred from a decline of 13 percent in orders and contracts awarded during the third quarter of FY19. Private investment is yet to pick up pace as major sectors where orders and contracts were awarded during FY19 are mainly in sectors such as Railways, Roadways etc, primarily driven by the government.
Though we are witnessing double-digit credit growth, the same is not broad based. Apart from retail, growth is being observed mainly in the power, roads and public sector enterprise sectors only. Capex led growth from listed companies is muted and working capital would remain key to credit growth. In NBFCs, growth is seen primarily to entities backed by better-rated entities/sovereign guarantees.
Auto sales are also not looking strong. All major auto companies are reducing their monthly production figures by 10 percent to 15 percent due to low demand and increase in inventories despite various
discounts offered to consumers. This suggests demand might be subdued in the near term.
Our inflation forecasts also suggest that, even though food prices may be just witnessing a minimal uptick, headline inflation will stay decisively below 4 percent till the third quarter of FY20. This is clearly substantiated by the procurement data published by NAFED (National Agricultural Co-operative Marketing Federation of India Ltd), suggesting uneven procurement across states. Also, the PM-KISAN Yojana is unlikely to have any material impact on consumption as Rs 75000 crore is only around 0.6 percent of private final consumption expenditure. Besides, historical trends suggest that during the years when general elections are held, there is a significant jump in revenue expenditure which directly impacts consumption growth and it slows down thereafter. Thus, the net effect on consumption could go either way, but it is unlikely that this cash transfer will have a significant impact on inflation.
We also believe that RBI might look into the liquidity framework in a more holistic manner. All scheduled commercial banks are holding excess securities of around 6.46 percent of NDTL (Net Demand and Time Liabilities). However, as per the LCR (Liquidity Coverage Ratio) requirements, banks are required to hold HQLA (High Quality Liquid Assets) equal to 100 percent of net cash outflows, equivalent to 19 percent of NDTL currently. Of this 19 percent HQLA, currently banks can only use 15 percent—13 percent FALLCR (Facility to Avail Liquidity for Liquidity Coverage Ratio) and 2 percent MSF (Marginal Standing Facility) -- from the mandatory SLR (Statutory Liquidity Ratio) of 19.25 percent. Thus, excess SLR has to be used to fulfil the LCR requirement of maintaining HQLA at 19 per cent of NDTL.
Hence only around 2.46 percent of NDTL is the excess SLR that is available in the system that can be used as collateral for banks from borrowing from the repo market. We expect RBI may take meaningful steps for increasing Government securities which then can be used for subsequent open market operations (OMO), say by aligning SLR and FALLLCR. The recent RBI swap transaction bears testimony to the fact that banks do not have enough securities for OMO. As an alternative, CRR (Cash Reserve Ratio) estimates could be made part of LCR.
So what we are betting on for April 4? We expect at least a 25 bps rate cut (cumulative 50 bps over next 2/3 policies) though we believe the stage is ripe for a larger rate cut. If the rate cut is of 25 bps only, then RBI could indicate more cuts through a possible shift in stance/ policy statement.
(The author is Group Chief Economic Advisor, State Bank of India. Views are personal)
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