The forthcoming monetary policy (4th October) will take place in the backdrop of the government’s fiscal push. The moot point then is whether it reduces the scope or need for monetary easing. We don’t think so. This is because: a) growth still needs monetary support as tax cuts, while a definite positive in the long run, may provide only modest support in the near term . b) The manufacturing sector is facing deflation; hence it is imperative the RBI cuts rates aggressively to ensure that real rates don’t rise; else debt servicing could pose a challenge (a la 2014–16). c) Risk aversion in the financial system is still high and requires continued monetary support. Indeed, there is a strong case for the RBI to fully accommodate the fiscal push (a la 2008–09 stimulus); otherwise, a rise in bond yields could undermine efficacy of the fiscal push (a la US 2018 tax cuts). All in all, we expect the RBI to cut the policy rate by 35–40bps at its forthcoming meeting and another 35–40 bps in the rest of FY20 (i.e. further easing of at least 75bps). And the same must be accompanied with sustained surplus in systemic liquidity.
Monetary policy should complement fiscal push…
In order to revivie the domestic economy, the government has announced several fiscal measures—the latest being a sharp reduction in corporate tax rates. This could lead to a fiscal stimulus of INR1.45tn (about 0.7% of GDP). It is imperative that the RBI complements this fiscal push (which it has always done historically) with lower rates/continued OMOs to support aggregate demand. Else, bond yields could rise, which would offset the positive impact of tax cuts in the near term—similar to what happened in the US in 2018. Thus, we maintain our stance of another 65-75bps of easing in FY20. In fact, we believe the RBI will cut more than 25bps in this policy as a signal to markets that it is accommodative of the governments’ fiscal push.
…growth and inflation dynamics also warrant more aggression
The domestic economy is clearly in the throes of a broad-based growth slowdown. The deflation in manufacturing is more worrisome as it is pulling down nominal GDP growth. While the RBI targets only the CPI, it is imperative that it takes into account the WPI as well; else, corporates may find it harder to service debt (a la 2015–16). In fact, despite the 110bps rate cut by the RBI in 2019, the real rates for businesses (based on WPI manufacturing) have actually risen. Finally, animal spirits too have smothered. Thus, the RBI needs to be fully supportive.
Guidance, policy steps on transmission on radar
The monetary policy expectation is not just limited to rate cuts. What’s perhaps more important at this stage is to ensure their quick transmission. While aggregate liquidity conditions have improved, transmission remains slow. The RBI’s assessment of the same will be critical. Apart from this, we would watch out for the central bank’s assessment of the NBFC situation and any regulatory developments thereof.