- Ranjan Chakravarty
Since the stance of the RBI is transparent, the market seems to have already priced in a cut of 25 basis points in the next policy announcement, as we speak. Hence, as terminology goes, any moderate easing as such can be defined for now as rate cuts in excess of 25 basis points, and deep easing as cuts in excess of 50. Earlier, we had strongly argued that cuts of 35 basis points and more would suffice to propel growth up until the point of the last RBI policy announcement, which came soon after the extremely welcome tax cuts by the Finance Ministry, and in fact had not been enthused by the gently graded approach that the Monetary Policy Committee had decided to adopt.
This was because aided by benign inflation, aggregate demand and supply had aligned as well as they had all year long, right until the first week of October, and as long as this alignment held, we consistently recommended the radical easing of rates in order to push credit off takes and to jump-start growth.
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Today the situation is different and that opportunity has been lost. As we survey the economy as on the last week of November 2019, which just predates the RBI policy week, we highlight two important facts that should be taken cognizance of. First, we note that the Finance Ministry, very correctly, has decided to make a strong capital injection into the Public Sector Banking system. However, this can be seen as a general credit enhancement on the back of the spurt in lending around and post Diwali.
This coincided with the seasonal revival of demand in the automobile sector, which cannot be said to have turned around on the supply side. It has to be seen whether this infusion is palliative or will have a more permanent impact and that cannot be measured within the space of this quarter.
Second, as at the end of November, we observe that retail inflation has begun to jump at the highest rate in the last six quarters. The slowing growth and rising inflation conundrum cannot be addressed by one time radical measures. We refrain from calling its stagflation as yet, as this price jump is restricted mainly to retail as of now. Once wholesale prices begin to jump, then the general price level will rise, and in the presence of slowing output growth, we could have stagflation. But that point is not here just as yet.
The decision in front of the Monetary Policy Committee (MPC), in our view, is whether to push for moderate easing or deep easing. Clearly, merely a 25 basis point rate cut would be a waste of precious ammunition since it would signal continuity but no true impact. So if we look at the two potentially impactful policy choices, then they would be either moderate easing or deep easing. Let us look at both.
First, let us assume the choice made by the MPC is moderate easing, i.e., a 50 basis point cut. In that case, it would be clear that beyond the stance (25 basis points), all that remains is the next 25 which would go directly to short term inflation management. If this is the case it would be clear that growth is to be tackled later-after the alignment of aggregate supply and demand referred to above is achieved again-a classic case of keeping the policy powder dry.
In case the MPC chooses the deep easing route, i.e., sets out both to manage inflation and boost growth as joint priorities, then 75 basis points is the minimum cut required. After the first 25, which is already priced in from the declared stance, the next 25 is for inflation management and at least 25 have to go towards growth. 50 towards growth would be even better, meaning a solid 100 point cut should be on the cards this one time. It may be dramatic but it will save the RBI from expending a lot of policy ammunition going forward.
It is now up to the MPC to make its choice as we head into the last policy announcement of the calendar year.
Ranjan Chakravarty is a Product Strategist at Metropolitan Stock Exchange (MSE). Views expressed are the author’s personal.