Accommodative Monetary Policy – Central banks attempts to expand money supply, by cutting

interest rates in order to boost the economy when growth is slowing down.
[9]
Moreover, monetary policy is more effective in tackling inflation than in kickstarting growth. You can
take a horse to water, but you can’t make it drink. That’s the domain of fiscal policy.

Oct 6 Economic Goldman Sachs experts expect RBI to cut repo rate once again by 25 basis point,
Times [1] bringing the final repo rate to 4.9%. Globally central banks (including India and
US) are taking an accommodative stance


India’s retail inflation rate 3.21% in August[2]
 The India 10Y Government Bond has a 6.641% yield.

Sept 21 Business  RBI governor Shaktikanta Das said – India cannot go down to the
Today [3] level of advanced economies because of an inflation target of 4%
 Global central banks have inflation rate of around 2%
 A top Niti Aayog official says there is easily a scope for another 100
basis points reduction in the repo rate from 5.4 per cent to 4.4 per
cent given interest rates continue to be stable or follow a
downward trajectory

Sept 10 Mint [4] [5]  The Taylor Rule is sensitive to a bagful of assumptions—about the
neutral interest rate, potential economic growth, optimum
inflation and the relative weight given by the central bank to
inflation versus growth. All these variables are not directly
observed, which ensures that the Taylor Rule is a broad guide
rather than a precise policy tool. The neutral interest rate is the
rate at which an economy is on an even keel, neither overheating
nor operating below potential.
 Assuming that Indian economic growth right now is 1% point
below potential, inflation is 0.5% point below target and RBI
gives equal weight to inflation, as well as growth, then a simple
application of the Taylor Rule suggests that the repo rate should
be at 4% when the neutral interest rate considered is 1.25%.
However, the neutral interest rate itself is sensitive to the business
cycle. Low levels of neutral interest rates—at 0.75% and 0.25%—
put the repo rate at 3.5% and 3%, respectively.

*Neutral Rate of Interest - Interest rate that would prevail when the
economy is at full employment and stable inflation: the rate at which
monetary policy is neither contractionary nor expansionary.
Function of the economy’s underlying characteristics and is not set by the
Federal Reserve. It’s usually discussed in real terms, that is, with inflation
 subtracted out. The neutral rate cannot be observed directly; it can only
be estimated.
Interest rates need to be high enough to convince savers to
save and low enough to incentivize borrowers to borrow.
The interest rate that does this in the long run is the neutral
rate of interest

Oct 4 RBI [6] Monetary transmission has remained staggered and incomplete. As
against the cumulative policy repo rate reduction of 110 bps during
February-August 2019, the weighted average lending rate (WALR) on
fresh rupee loans of commercial banks declined by 29 bps. However, the
WALR on outstanding rupee loans increased by 7 bps during the same
period.

Outlook

Oct 4 RBI [6]  The CPI inflation projection is revised slightly upwards to 3.4% for
Q2:2019-20 from 3.1%, while projections are retained at 3.5-3.7%
for H2:2019-20. Inflation @3.2% for Q2.
3.6% for Q1:2020-21,
 First, the outlook for food inflation has improved considerably
since the August bi-monthly policy.
 Secondly, forward looking surveys conducted by the RBI point to
weak demand conditions persisting, with indications of softening
of output prices in Q3:2019-20
 Thirdly, crude oil prices may remain volatile in the near-term;
while global demand is slowing down, the persisting geo-political
uncertainties pose some upside risks to the inflation outlook.
 Fourthly, 3-month and 1-year ahead inflation expectations of
households polled by the Reserve Bank have risen in the current
round reflecting near-term price pressures.
 Finally, financial markets remain volatile with currencies of
several emerging market economies trading with a depreciating
bias in the recent period.

Oct 4 RBI [6]  Real GDP growth for 2019-20 is revised downwards from 6.9% in
the August policy to 6.1%– 5.3% in Q2:2019-20 and in the range
of 6.6% - 7.2% for H2:2019-20 – with risks evenly balanced.
Q1:2020-21 is also revised downwards to 7.2
 Various high frequency indicators suggest that domestic demand
conditions have remained weak. The business expectations index
 of the Reserve Bank’s industrial outlook survey shows muted
expansion in demand conditions in Q3. Export prospects have
been impacted by slowing global growth and continuing trade
tensions.
 On the positive side, however, the impact of monetary policy
easing since February 2019 is gradually expected to feed into the
real economy and boost demand. Several measures announced
by the Government over the last two months are expected to
revive sentiment and spur domestic demand, especially private
consumption.

Oct 4 Economic Reasons for rate cut - Retail inflation for August stood @ 3.2%, and the
Times [7] government’s recent measure to ban onion exports helped ease some
concerns any imminent spike in food inflation.
A volatile global trade scenario and uncertain geopolitical environment,
which led to the weakening of demand globally, are some of the other
reasons favored a rate cut.
Despite recent government measures to strengthen private consumption,
there still exists a negative output gap (when actual output is less than
what the economy can produce at full capacity)

Given the concerns on growth and inflation remaining within the target levels, a majority of analysts
were expecting the RBI to cut rates at the review.

Das had also recently said the prospect of benign inflation during the remainder of FY20 gives it the
room to cut rates. – Forward looking statement

Oct 8 Hindu  RBI has compelled banks to pass this favor to the customers by
Business aligning loans to this external benchmark.
Line [8] But in reality effective lending rates on home loans have at best
fallen by 70-75 basis point – poor transmission of policy rate
actions
 For instance, for home loans in the ₹30-75 lakh bracket, SBI’s
lending rate in September under the earlier MCLR structure was
8.55%.
 Under the new repo-linked scheme, the effective lending rate
stood at 8.45%.
 From Oct 1, banks had linked benchmark to RLLR and not MCLR for
faster transmission.
 There is an avenue for further rate cut. But rate cut is not going to
be the only panacea, if at all it is the panacea. Can RBI dictate the
 bank to reduce the spread over repo (or MCLR) it puts to pass this
favor to the customers?
 On the regulation and supervision front, the RBI decided to
increase the household limits for micro-lenders’ borrowers, and
also raise the cap to Rs 1.25 lakh per eligible borrower from the
previous Rs 1 lakh.

Oct 8 Economic Governor hinting at further rate cuts – “No, how much policy rate is
Times [9] around the lower bound - we have not said anything about it. What we
want to say that we are giving some kind of forward guidance that as long
as growth momentum remains as it is and till the growth is revived, the RBI
will continue to remain in an accommodative mode.

"So, you cannot make a conclusion out of it on what is the minimum rate,
what is the minimum repo rate where the RBI will take a pause”

Oct 4 Financial  This is part of the trend and effort on the part of RBI to do
Express [10] whatever it can to support and revive the growth.
[11]
We all know that fiscal space is very limited yet the government
announced a tax rate cut and there is a hope that there will be an
income tax rate cut as well,” said Sunil Sinha, Principal Economist
of India Ratings.
 In its policy announcement, the Reserve Bank also made it clear
that more rate cuts were in offing. The RBI’s job has become a lot
easier as crude oil and commodity prices are at a low level. Also
inflation is at low levels, so there is space for more rate cuts
 “Both, bond and equity markets may be slightly disappointed with
the slightly lower than expected rate cut of 0.25 per cent.
However, the dovish statement accompanying the policy
resolution which keeps the door open for future rate reductions
should act as some sort of a solace. Also, RBI placing importance
on quick monetary policy transmission is also an important
indication of the possible measures that the central bank may take
in the near future,” said Dheeraj Singh - Head of Investments &
Fund Manager .
Sources:
1. https://economictimes.indiatimes.com/markets/stocks/news/rbi-may-again-slash-rates-in-
december-says-goldman/articleshow/71465694.cms
2. https://economictimes.indiatimes.com/news/economy/indicators/august-retail-inflation-rate-
climbs-rate-cut-hopes-still-high/articleshow/71097781.cms?from=mdr
3. https://www.businesstoday.in/current/economy-politics/how-much-more-can-the-interest-
rates-come-down-in-india-given-the-inflation-target-of-4-per-cent/story/380486.html
4. https://www.livemint.com/opinion/columns/how-low-can-interest-rates-go-in-addressing-the-
downturn-1568136168668.html
5. https://www.brookings.edu/blog/up-front/2018/10/22/the-hutchins-center-explains-the-
neutral-rate-of-interest/
6. https://www.rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=48319
7. https://economictimes.indiatimes.com/markets/stocks/news/rbi-cuts-repo-rate-by-25-bps-to-5-
15-lowest-since-march-2010/articleshow/71435390.cms
8. https://www.thehindubusinessline.com/money-and-banking/cheaper-home-loans-not-
necessarily-so-dont-rush-to-borrow/article29616202.ece#
9. https://economictimes.indiatimes.com/news/economy/policy/view-why-mpc-should-tread-
cautiously-on-key-policy-decisions/articleshow/71470061.cms
10. https://www.financialexpress.com/money/rbi-rate-cut-hope-for-more-rate-cuts-passing-of-
benefits-to-consumers-would-benefit-mf-real-estate-investors/1726685/
11. https://www.financialexpress.com/money/rbi-repo-rate-monetary-policy-october-2019-impact-
on-home-loan-car-personal-emi/1726320/
12. https://www.financialexpress.com/economy/rbi-set-to-cut-rates-again-as-fiscal-measures-fail-
to-cheer/1724200/
13. https://www.financialexpress.com/industry/sme/msme-fin-msmes-hope-near-future-benefits-
from-rbi-rate-cuts-seek-mindset-change-for-bankers-towards-lending/1729086/
14. https://www.businesstoday.in/sectors/jobs/unemployment-rate-hits-three-year-high-of-84-in-
august-cmie/story/377306.html - unemployment rate
15. https://www.ndtv.com/opinion/opinion-how-to-fix-the-economy-the-message-is-clear-2112840
- demand vs supply side_1
16. https://www.hindustantimes.com/india-news/why-the-2019-slowdown-is-different-from-2012-
13/story-XuRgL94L1g82EaLGqasmAJ.html - demand vs supply side_2
17. https://economictimes.indiatimes.com/news/economy/indicators/gst-collection-slips-below-rs-
1-lakh-crore-mark-to-rs-91916-crore-in-september/articleshow/71393442.cms - GST September
revenue collections
18. https://www.moneylife.in/article/how-lower-inflation-lowered-economic-growth-with-many-
knock-on-effects/58040.html - Effect of low inflation-low growthx
The reason for this economic slowdown is partly cyclical and partly structural.
Let’s address the cyclical issue first. Any economy goes through ups and downs which
are a part of the business cycle. The central bank’s expansionary and contraction policy
plays a part to control this cyclicity using monetary policies.
Let’s take the current Amazon and Flipkart Big Festival sale as an example (29 Sept-5
Oct). Although the current sale generated higher revenues compared to the previous
years ($3 billions in 2019 vs $2.3 billion in 2018 vs $1.3 billion in 2017, according to
Redseer consultancy), the growth has slowed down this year from 72% to 30%, despite
witnessing an increase in buyers from Tier II and III cities. Consumers are willing to
spend but are not able to because of lower incentives.

Structural issues on the other hand, alone cannot be worked on by tinkering with
monetary or fiscal policies. The economy currently is facing slower consumption and
lesser foreign investments, which is a mix of internal and external factors.
To curb slower consumption, government has taken steps to reduce the incorporate tax
from 30% to 22% for domestic companies and also reduce GST in several products.
Regarding former, we assume that the gain incurred from taxes, will be either used to
pay off the debt or pass the benefits to customers in the form of discounts.
Reduction in the corporate tax rate, ideally, should also boost fresh investments
.

First, the banking system, which forms the backbone of the economy, requires the
biggest structural reform. Currently credit lending from the bank is slow and weak,
despite Indian banks levying one of the highest spreads (difference between depositor
and lending rate) among emerging and developed economies. Lowering repo rates in
the hope to pass on the benefits to the customer hasn’t proved much beneficial yet (of
the 135 basis points cut, only about 29 basis point reduction has been observed)

Second, massive NPAs have become one of the major reason for this slow credit
lending. IBC (Insolvency & Bankruptcy Code) which was implemented to resolve such
issues within a minimum time frame (180 + 90 days), hasn’t proved much efficient
either. Inadequate infrastructure that handles the vast amount of cases and legal
procedures, delays the procedure, which leads to further fall on the expected return on
the assets, rendering the entire code inefficacious.
Then we have the flawed GST brackets, and unproductive agricultural sector,
privatization of certain sectors, etc. Respective reforms in these sectors will help
generate jobs, income growth and confidence in consumers to rest faith in the
economy.
Agricultural sector
The timing of demonetization and GST. Government still has not been able to stabilize
the GST brackets for different products

According to RBI’s recent estimates, the real GDP growth has been re-estimated to 6.1%
down from 6.9% for the Q3 and 6.6-7.2% for H2: 2019-20
Additionally, CPI inflation was also revised to reach expected levels of 3.4% for Q2 from
3.1% and 3.5-3.7% for H2: 2019-20. RBI aims to keep the inflation rate on an average to
4%.
But what do these numbers depict? India will have to look for other avenues to restore
its GDP growth to former levels of 8% and higher to become at fastest growing
economy while also keeping the inflation at expected level of 4%.
The country is facing an economic slowdown due to lower consumption and lesser
foreign inflows. Volatile global trade scenario (US-China trade wars and oil price
fluctuation) has eroded the trust in the depreciating INR and led investors to invest in
other safe haven.
Even the forward looking surveys by RBI have pointed to feeble demand conditions,
indicating that the slowdown is going to persist longer and may turn to recession.
To tackle this issue, the central bank and the government have taken what they think
are the necessary steps. From reducing the repo rate by 135 basis point (RBI’s fifth
meeting this year) to cutting the corporate tax from 30% to 22% for domestic
companies and also reduce GST in several products. Regarding later, it is assumed that
the gain incurred from taxes, will be either used to pay off the debt or pass the benefits
to customers in the form of discounts.
But the major measures that have been taken have addressed the supply side. The
current slowdown is due to demand issues. Household incomes have not been growing
as fast as the consumption which have led the households to cut on the savings.
Unemployment rates are at a 3 year high (8.4% in August - CMIE), a part of which can
be attributed to the effects of demonetization. The low inflation-low growth period
clearly indicates that this is a demand side issue.