Rate cuts are merely rearguard actions
Economist R K Laxman once published a cartoon suggesting that the solution for every ill in the economy was for the RBI to cut rates by 100 bps! Humour aside, the central bank actually did that and more in recent months. That its actions failed to charm markets and manufacturers is entirely its own doing, given last year’s unwarranted tight monetary policy.
It’s important to understand that the ongoing rate cuts are merely rearguard actions rectifying past errors than a forward march. As former RBI Governor Raghuram Rajan noted, we can either have low rates or low inflation, not both. But that’s exactly what is happening. Inflation will likely stay sub-4% in FY20, while rates are going downhill. With the Monetary Policy Committee’s prolonged rate easing cycle, the real question is, how much more room does RBI have?
Markets are factoring 4.5% as the likely floor for repo rate this fiscal, but despite Friday’s move, markets and rupee ended in red, while bond markets sulked on fears of a potential 40 bps breach in the fiscal deficit target. The latter could be arrested with a rise in tax collections, but for that to happen, interest rate transmission is critical to kickstart the capex cycle. Given that a mere 29 bps, of the 110 bps rate cut, went to new borrowers, banks have plenty of ground to cover.
The real shocker was the sharp reduction in FY20 GDP forecasts from 6.9% to 6.1%. As Governor Shaktikanta Das admitted, the June quarter’s 5% growth, which RBI didn’t see it coming, was ‘worse than all predictions.’ Perhaps, avoiding further embarrassment, the MPC appears to have either exercised extreme caution lowering estimates or accepted slowdown reality with reluctance.
Truth is, consumption and investment remain weak, while revival measures were somewhat dead on arrival. That leaves the recent corporate tax cuts and interest rate reductions as the final lever to spur consumption and JAM (just about manage) the economy.