OPINION | There’s a window of opportunity now for a repo rate cut

While deposit rates have responded faster, transmission has been slower for lending rates.

The repo rate set by the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) remains unchanged at 5.5% since June, after cumulative cuts of 100 basis points (bps) this year.

Two-speed transmission

For all the easing, however, the transmission of monetary policy is yet to reach its full potential. The effects yielded so far: more than 100 bps decline in the 91-day Treasury bill, ~90 bps in the two-year government security (G-sec), ~50 bps in the five-year G-sec and ~30 bps in the 10-year G-sec.

Transmission to the bond market, therefore, has been relatively swift, particularly in short-term instruments, aided by overnight liquidity support.

In the bank credit market though, there is some distance to cover. While deposit rates have responded faster, transmission has been slower for lending rates. The consequence is that the benefits of easing have not fully reached borrowers.

A rate cut can sustain consumption revival

In the first few months of this fiscal, growth in the Indian economy has been strong, driven by strengthening rural demand, early export shipments and faster government capital expenditure (capex).

However, continued support will be essential as India braces for headwinds from weaker global growth and higher US tariffs on its exports.

So far, the government has flexed its fiscal muscle by cutting the goods and services tax (GST) rates, providing income tax reliefs and frontloading capex.

The monetary policy has also been supportive of growth.

However, the inflation trajectory suggests scope for another rate cut, which, if frontloaded and complemented with appropriate nudges for better monetary transmission, can help sustain a broad-based consumption revival.

Fair to surmise the metaphorical ball has landed in Mint Road.

Inflation allows breathing space

At present, benign inflation allows the MPC the elbow room to ease the policy rates.

The headline Consumer Price Index (CPI)-based inflation has remained low through this fiscal, averaging 2.4% so far. Crisil expects the full-year number at 3.2%, comfortably below the RBI’s target of 4%.

Rationalisation of rates by the GST Council, which lowered taxes on ~22% of CPI basket items, is likely to be a powerful disinflationary force. This should, in theory, open the doors for further rate cuts.

However, the MPC will be mindful of the inflation trajectory. The fading statistical base effect from October could push up inflation from current levels, particularly for food categories. Food price volatility, if at all caused by excess monsoon, could also weigh on inflation. Yet, the core part of the index (that is, excluding food and fuel categories) will see greater relief due to the GST cuts.

The challenge for the MPC is to use the present window of opportunity before it begins to close.

Uneven growth needs support

The case for monetary easing amid stable inflation is also strengthened by the uneven nature of domestic demand in the economy. While rural demand has held up relatively well, supported by farm incomes and lower inflation, urban demand is tepid amid cautious household discretionary spending.

The investment cycle, too, is yet to pick up. Private investment, held back by global uncertainty, is still awaited, with domestic capacity utilisation showing only a gradual improvement.

To be sure, corporate sentiment is not uniformly negative, but it is not exuberant either. While large companies have been able to raise funds at lower costs in the bond market, many others still face higher bank lending costs.

A further push to credit growth, nudged by lower interest rates, could help bridge the gap.

Global headwinds cannot be ignored

The global economic environment is neither hostile nor benign at present. Trade flow remains weak and global investment sluggish, slowing down large economies.

Global commodity prices remain stable for now. That offers India some comfort, given its huge dependence on energy imports. But simmering geopolitical uncertainties keep these prices on the edge.

The first quarter of the fiscal saw gross domestic product (GDP) growth holding up, supported by strong domestic demand. Crisil forecasts India’s growth at 6.5% this fiscal, in line with the previous fiscal, but with a downside bias.

Much depends on how the global slowdown plays out and how the domestic economy holds up. In the base case, we expect strong domestic demand—riding on consumption and public investment—and favourable financial conditions to partly offset the weakness from global growth.

The case for a calibrated cut

Amid low inflation, uneven growth and looming global risks, the case for a calibrated rate cut is compelling as the MPC goes into a policy review meeting in October.

The base case should be a 25 bps cut during the October review of the monetary policy. The policy stance is expected to be neutral, with a commitment to remain data-driven.

Such a cut could complement fiscal measures implemented so far this year, reinforce consumer sentiment during the festival season and nudge credit growth. It would also signal intent to support growth without being complacent on the inflation front.

North Block has played the fiscal card. Now for the MPC nudge.

(Dipti Deshpande is Principal Economist at Crisil Ltd.)

Views are personal and do not represent the stand of this publication.