Suyash Choudhary

The elections handing over a continued strong stable government is welcome relief to market participants. In particular, it will help keep India’s country risk premium stable amongst its peers. With this out of the way, local policy can afford to start focusing emphatically on the evolving macro narrative. This is marked by a synchronized global slowdown which has been underway since late last year and has caused major central banks to start leaning dovish since early this year. Moreover, India’s own growth and inflation dynamics remain soft as well. The Monetary Policy Committee (MPC) has so far responded with two rate cuts, but there is little that has been achieved by way of transmission.


The following recent developments are noteworthy:

1. While the domestic auto sector has been showing a significant slowdown for some time, there is now a sense of the consumption slowdown spreading more generally as well.
2. The credit aversion in parts of the financial system that seemed to be stabilizing earlier in the year seems to have been aggravated again recently.
3. The global narrative on growth which was beginning to look somewhat optimistic again post the US Fed pivot and recent Chinese expansion of credit has turned murky once more with hopes around a US – China deal having been disappointed for now.;
The Government’s Constraints


There is little doubt then that India, alongside most of the world, is in the midst of a cyclical slowdown. It is noteworthy that this slowdown is despite the fiscal ‘expansion’ that has happened over the past year or so. Most of this expansion seems to have happened almost involuntarily as revenues on GST have meaningfully undershot expectations. Furthermore, with the likely undershooting of FY19 tax revenue numbers from even the revised estimates in the budget, the year on year growth rates implied in the FY 20 interim budget numbers look very aggressive.


It is clear then that there is very little room for the government to step up spending in any meaningful manner in the immediate future ahead. In fact in the interest of credibility it would be prudent for the government to restate the fiscal deficit taking into account the actual revenue outcomes for this year and the substantial usage of below the line items in financing the budget. It is to be clarified that some deployment of counter-cyclical fiscal expansion given the macro narrative wouldn’t be amiss at all. However, the incremental room as discussed here is limited. More importantly, the bond supply associated with this level of deficit is leading to genuine crowding out and elevated nominal bond yields despite very low inflation. Thus, there is a macro impact of elevated long term real yields that needs to be taken into account when thinking about an incremental fiscal stimulus. Some avenue for extra spending may come about if the government gets a significant transfer of capital from RBI. The government may also focus on more substantial monetization of its assets in order to increase spending without appreciably breaching a fiscal consolidation framework. Ultimately, however, true fiscal flexibility will have to wait till recent tax reforms bear fruits respecting the so-called ‘J’ curve, especially in the case of GST.


Player One: The RBI


The maximum ‘room’ as it were resides with monetary policy currently, in our view. Consumer Price Index (CPI) has tracked lower than the mid-point of the official target band for a while now. Furthermore, it is likely to remain relatively benign in the foreseeable future as well, even accounting for some upside to the RBI’s assessment for the year ahead. Major global central banks have turned dovish on the margin.  Our election verdict will serve to possibly compress India specific risks somewhat versus other similar emerging markets. The local growth narrative is one of a visible slowdown. Various sectors like real estate and telecom remain relatively stressed and income growth remains muted. Sections of the financing market are clogged and may have served to prematurely impact the consumer leverage cycle which, in the absence of any significant upturn in incomes, is possibly what is visible now in slowing consumer demand. In short, in the real world it is difficult to worry about demand side inflation at least in the near term. Despite this scenario, real rates remain high even at the short end and policy stance remains neutral. Also even though core liquidity has turned positive for now, the RBI’s stance on it remains unclear to market participants.


We had highlighted in a recent note ( 3 areas where, in our view, there is scope for RBI (and to some extent MPC) to more fully examine and utilize the tools available. Drawing from this framework, we think it is desirable for the MPC to shift monetary policy stance to accommodative. Furthermore, from an RBI standpoint, an indeterminate stance on liquidity (though backed over the past few months with stepped up efforts at liquidity creation) may no longer be enough. Market participants need to be assured of sustained positive liquidity for near term spreads to come down. The situation in some sense is similar to 2016 where Rajan had reacted by officially clarifying in the April 2016 monetary policy review to “continue to provide liquidity as required but progressively lower the average ex ante liquidity deficit in the system from one per cent of NDTL to a position closer to neutrality”. In our view, the time may be opportune to similarly officially state in the monetary policy review the intent to move liquidity to some sort of surplus (say, 0.5 or 1 % of NDTL). The shift in stance combined with this stated intent of affirmative action on liquidity may go a long way in improving transmission at least so far as the money market curve is concerned. Also given the very narrow policy corridor now, such a move cannot be interpreted as ‘back door’ policy easing by any stretch of the imagination.


The Objections to Monetary Easing (And Why We Don’t Agree With Them)


Two objections that are sometimes made to additional monetary easing are as follows:

1. It won’t matter to the NBFC issue:  There are two aspects to the problem currently. One, near term spreads are extremely volatile and generally elevated. Two, the credit spread over the risk free has widened significantly for a section of the market. To be clear, any change to liquidity stance is only aimed at addressing the first issue. As an example, spread of 3 month bank CD to repo rate had recently widened to almost 125 bps over the repo rate, despite it not being busy season any more. It has fallen since largely on market’s expectation of further monetary easing. This can be anchored more sustainably with the change in liquidity stance. The credit spread issue will work out over longer periods of time as balance sheet issues get addressed and risk perceptions stabilize. Unless there is a system destabilization risk (which doesn’t seem to be the case currently), there is little role for RBI here without inviting a moral hazard problem.
2. The previous stimulus of 2009 ended badly: The 2009 stimulus was of an extraordinary degree across fiscal and monetary policy, and wasn’t pulled back even when it was clear that the economy no longer needed it. The lesson is, of course, relevant. However, it is a stretch to not act now for fear of this repeating. The government has largely adhered to a fiscal consolidation framework despite pay commission pressures in the past few years. Challenges have recently surfaced mostly owing to GST disappointment but by no means are stability threatening. On its part the RBI/MPC are committed to a CPI targeting framework now and will presumably counterbalance any stimulus should CPI targets look sustainably under threat in the future.



The election mandate of a continued strong government  will help contain sovereign risk premium and allow policy to focus on the local narrative of slowing growth. The government seems to have little fiscal space given recent pressures and must balance incremental deficit expansion with the economy-wide cost of higher real long term rates. The RBI/MPC, on the other hand, have more room and should respond now with a more decisive focus on the guidance tool for both rates and liquidity. This, in our, view has the maximum chance to influence transmission. The view remains bullish on quality bonds (sovereign, SDL, AAA) and cautious on lower rated credit.


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