GDP Growth Slowdown: Expect Multiple Rate Cuts

The April-June 2019 gross domestic product print at 5.0 percent growth year-on-year came in as yet another rude shock and will certainly fuel further slowdown concerns. While a weak GDP print in this quarter was widely expected, most forecasters expected the same in the 5.5-6.0 percent zone.

GDP excluding agriculture grew at 5.4 percent YoY during Q1FY20, materially lower than close to 7.0 percent YoY during the previous three quarterly prints and about 8 percent during Q1FY19. Indeed, the weakness in non-agriculture GDP growth had been broad-based with manufacturing activities registering a growth rate of merely 0.6 percent YoY during the quarter ending June. Construction activities – which had recorded a better growth rate in the previous quarter – had again slipped during Q1FY20. The relatively strong government spending (8.5 percent YoY) during the quarter had been a saving grace for the headline GDP print. Activities excluding government spending recorded a growth of only 4.5 percent YoY during the current quarter, as against 7.7 percent YoY a year ago.

Nominal GDP growth – at around 8.0 percent YoY during the quarter – also tanked to a multi-quarter low reflecting a combination of weak real growth and persisting low inflation.

FY20 Growth Likely To Be Only Around 6%

Taking the current trends into account, it seems that GDP growth will likely register a weak number during the 2019-20 financial year. As regards the headline growth print, we have likely already hit a near-term low. However, recovery in the same might be a slow process as suggested by a host of lead indicators.

On balance, as against the Reserve Bank of India’s current projection of FY20 GDP growth of 6.9 percent, albeit with downside risks, we feel that headline GDP growth may come in close to only 6.0 percent during the year. Given GDP growth during the first quarter of the financial year came in at 5.0 percent, even 6.0 percent for the full year would require a significant uptick in growth prints during the second half of the year.

Nevertheless, given the ongoing rate cuts and liquidity infusion by the RBI, supportive steps from the government, and a materially favourable base effect during the latter part of the financial year, the expectation of better growth prints remain the baseline scenario during the second half of FY20.

Informal Sector Activities Less Impacted

While broader growth momentum seems to be facing stronger headwinds of late and the theme of so-called rural distress had been widely discussed in the recent past, we dare to flag our view that the current slowdown had been significantly more pronounced in the formal sector, for the more leveraged segments of industry, and at the higher end of consumption.

MPC Looks Set To Cut Rates More Than Once In The Coming Months

The RBI’s decision to cut the repo rate in the August Monetary Policy Committee meeting was well anticipated; continuing with the “accommodative” monetary policy stance was also widely expected. However, the quantum of the rate cut – by an unconventional 35 basis points – came in as a pleasant surprise. Given the evolving growth-inflation dynamics, the MPC looks set to deliver more cuts during the coming months. The current GDP print will likely influence the MPC materially to deliver yet another cut – potentially more than the usual 25 basis points – in its next meeting in early October.

Growth momentum remains weak in several other countries and many central banks – including the U.S. Federal Reserve – have again turned more supportive of growth lately. A relatively low oil price trajectory and the current more dovish policy stance of central banks globally offer the RBI greater elbow room.

One would expect the MPC to lower real interest rates more than once in the coming months against the current macroeconomic backdrop.

Weak Inflation Backdrop Offers MPC A Major Cushion

The current scenario on the inflation front remains markedly comfortable. While risks such as monsoon-related uncertainties and volatility in crude oil prices are difficult to ignore at most points in time in the Indian context, it is noteworthy that household inflation expectations have moderated of late. Indeed, headline CPI inflation remains markedly low, undershooting the RBI’s target, averaging sub-3 percent YoY over the last one year.

Core inflation (CPI excluding food and energy) has softened in recent months, offering a strong cushion for inflation expectations. Oil prices have largely remained anchored of late, despite occasional bouts of volatility. Headline CPI might register some uptick during the second half of FY20. However, that will likely be transitory and largely a reflection of a markedly adverse base effect, and far from any demand over-heating. The MPC will likely not be unduly worried due to such a possibility.

Bond Yields Might Soften Materially In The Coming Weeks

Bond yields had, of late, been volatile with a dovish bias. The 10-year Indian government bond yield moved within a relatively wide range of 6.30-7.10 percent over the last about three months. We feel bond yields will likely continue to be volatile within a range of 6.00-6.60 percent (or modestly wider) with a dovish bias in the near term. Accordingly, bond yields towards the upper end of this range will often offer a buying opportunity, in the near term in our view, as it is doing currently with Friday’s close at 6.56 percent. On the other hand, we see a case to turn more cautious on bonds if the benchmark 10-year yield softens close to or beyond 6.00 percent in the near term.

While we expect the government to keep announcing a certain set of measures to help the economy, any large-scale fiscal spending-based stimulus package may not be the best approach at this moment and is not the baseline expectation in the near-term, according to us.

Siddhartha Sanyal is the chief economist and head of research at Bandhan Bank.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.