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RBI may cut repo rate by at least 25 bps, says Pankaj Pathak of Quantum Mutual Fund

The banking regulator is expected to go for a sixth consecutive interest rate cut on Thursday, especially after the country's GDP growth dipped to 4.5% in the July-to-September 2019 quarter.

Last Updated: Dec 04, 2019, 12.13 PM IST|Original: Dec 04, 2019, 12.01 PM IST
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By Pankaj Pathak

The Reserve Bank of India is facing a tough task amid waning economic growth and rising consumer inflation - at least in terms of headline numbers. The economy has been slowing down for the last six quarters. The GDP growth has hit a multi-year low of 4.5% in the July-to-September 2019 quarter. It has again fueled hopes of another rate cut by the RBI, despite a sharp jump in the retail inflation.

The consumer price inflation has risen mainly due to unseasonal spike in few vegetable items and does not reflect any broad-based inflationary pressure. The core inflation (excludes food and fuel prices), which is more closely linked to the economic cycles, has been coming down consistently since the start of the year.

This suggests that the underlying inflation trend is still muted, and in the wake of sluggish demand outlook, it is likely to remain subdued in the near future. We believe that RBI needs to look through the recent jump in headline numbers and should continue to focus on reviving growth.

The RBI has already cut the policy repo rate five times this year by cumulative 135 basis points (100 basis points equal to 1%). Moreover, it has also pumped the banking system with liquidity which is now in excess of Rs 2 trillion. Despite this, the credit markets have not shown any notable signs of easing. Banks have been reluctant to reduce lending rates. The average marginal lending rate has come down by a mere 45 basis points in the last nine months.

The RBI had also shown its concerns about the sluggish transmission of the monetary easing into the real economy. It still remains a challenge, and RBI have to address the issue sooner than later. In the last few months, they started experimenting with various external benchmarks, but in our view nothing seems to be working till now.

One way of facilitating the monetary transmission would be effective communication or future guidance on the policy rates and liquidity conditions. The RBI governor, in one of the press conferences, scrapped the real rate framework which has created an ambiguity among the market participants in forecasting an extent of monetary easing. In the earlier regime under Dr Rajan and as well as Dr Patel, the RBI used to target a real rate of 1.5%-2.0%.

Under the current circumstances, it has become imperative that the RBI shows its commitment on going significantly lower on rates and keeping lower for longer.

This takes us to the next big question. How much space does the RBI really have? Some suggests that it has limited room to stimulate growth. Some others believe that the monetary policy is ineffective in the current scenario and will not be able to lift the economy.

In our opinion, we need to approach these issues in an objective way and need to become more surgical in evaluating the impact of monetary policy. Most of the assessments on the terminal repo rate or monetary space are based on historical real rate framework. However, there are various academic research which suggests that along with the nominal policy rates, real rates should also be countercyclical.

Given the GDP is growing at a pace well below its potential; there is a case for very low or even zero real rate. While working with real rates we should also keep in mind that there are multiple inflation indicators showing very different pictures.

Usually we work on the headline consumer inflation (CPI) numbers which has been on an upward path for the last few months. While on the other hand the Core-CPI and the Wholesale inflation (WPI) which are better proxy with reference to economic activity, both have been falling. With this in mind there is substantial monetary space with the RBI to boost demand and facilitate economic recovery.

We agree to the thought that reducing policy rate may not necessarily stimulate the growth immediately. But we should also acknowledge that keeping it high relative to underlying inflation might hurt the recovery process.

We believe that the RBI should not be overly worried about the potential fiscal breach at this point. There is a reasonable probability that the government may increase its fiscal deficit target but that would be due to shortfall in revenue which may not be inflationary.

We expect the RBI to cut the repo rate by at least 25 bps on Thursday and keep the door open for further easing. The bond market is already pricing for an easy monetary policy, though the RBI’s commentary on prevailing inflation and growth trends might cause some movement in yields. Investors in long duration debt funds should be prepared for increased volatility in the coming months as we approach the fiscal closing. Returns on liquid funds and other money market funds might come down further with rate cuts and easy liquidity conditions.

(Pankaj Pathak is a fund manager-fixed income at Quantum Mutual Fund)
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of

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