All eyes on RBI: Easing of monetary policy key to the revival of economic growth

After Budget 2020, all eyes on the RBI monetary policy.
Fiscal constraints limited growth impetus in Budget 2020. The market expects a pro-growth stance from RBI.

By Naliniprava Tripathy, Ayush Dharnidharka & Sushant Sant

After the Union Budget, the focus of the market is on the monetary policy guidelines for the next financial year, especially for the policy in the first quarter ending June. It is imperative to have a policy that will boost consumer and industrial demand for goods and services —considered crucial for deciding the future policy rates. Industrial output measured in terms of index of industrial production expanded 1.8% in November 2019 compared with October, which is seen as the first positive sign of a rebound in the economy. The growth in November was led by the manufacturing and mining sectors reporting an upside of 2.7% and 1.7% respectively.

The core sector (forms 40.27% of the weight of items included in IIP) growth for the period of Apr-Nov 2019 was zero, compared with 5.1% in the same period in 2018. Despite the core sector recording a negative growth of 1.5% in November 2019, specific sectors such as fertilizer and cement registered growth. The revival in these core sectors can be the silver lining for the first quarter of 2020-21, as not much is expected in terms of a turnaround in the last quarter of 2019-20 other than a slight improvement due to the base effect.

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Consumer price inflation for December jumped to 7.35%, breaching the comfort level of 4% (with a margin of 2% on either side) and recording a rise for the fifth consecutive month. This was mainly because of the upward pressure from the cost of food and beverages. However, the core inflation was 3.7% for the same period. This momentary spike should not be a significant concern as the rise was on account of seasonal influx and hence will cool off subsequently in the fourth quarter of FY2020.
Brent crude prices went down below $60 a barrel in January 2020 almost after 14 months of rally. The future prices will be guided by the next OPEC meeting slated for March and the US-Iran tension. However, the focus on alternative energy sources, Coronavirus outbreak in Wuhan and an overall slump in major global economies are expected to keep the prices under control in the near future.

There has been a sharp drop in exports during April-December 2019. Exports slipped 1.96% to $239.29 billion against imports of $357.39 billion. Further, the dollar has appreciated from December 2019 levels in the last two months. In this context, an expansionary monetary policy will result in currency depreciation giving exports more thrust. Therefore, keeping the expansionary policy is of utmost importance at this point.

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In its first advanced estimates released in January 2020, the Central Statistics Office has pegged the economic growth for 2019-20 at 5%, followed by IMF’s downward revision of India growth forecast to 4.8%. The RBI, too, has revised the estimates downward to 5% from its earlier prediction of 6.1%, which is in line with the view of CSO and IMF. However, the Union Budget presented by finance minister Nirmala Sitharaman has set the target of 10% nominal GDP growth for the next financial year beginning April. The government’s move to limit the fiscal slippage to a mere 0.5% may not give enough impetus to achieve the target, and hence the RBI needs to support the goals with a pro-growth monetary measure.

In this scenario, RBI is expected to keep the repo, reverse repo, and bank rates under the liquidity adjustment facility at the current level and give an accommodative stance to support economic growth, keeping inflation within the target. There has been a rate cut of 135 basis points during February-October 2019, the monetary transmission across fixed income securities especially, short-term markets such as call money market and CPs of NBFC has been swift. However, the said transmission has not been achieved for end consumers, and a directive in this respect to the commercial banks is the need of the hour. Hence, a regime indicating that the initial rate cuts of Apr-Dec 2019 are passed on to the end consumers or industry will be necessary.

Monetary policy is a prerequisite to having a sustainable economic growth with price stability. High inflation is detrimental to the long-run economic performance and prosperity. When the banks ease lending, it enables the businesses and households to raise spending. Stocks will become an attractive option in a low interest-rate regime nurturing households’ financial asset that contribute to increasing consumer spending. Low-interest rates also tend to cause currency depreciation since, boosting the demand for domestic goods as imported goods will become expensive. All these factors tend to raise output, employment, investment, and consumer spending.

(Prof Naliniprava Tripathy teaches finance at IIM Shillong. Ayush Dharnidharka and Sushant Sant are PGP final year students.)