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Does India really need another rate cut amidst the Coronavirus outbreak?

Global markets suffer bloodbath as Coronavirus remains rampant globally

Global markets have corrected more than 20% in the last month, owing to the novel COVID-19 pandemic and fears of an on-setting recession. Countries have witnessed large-scale slowdowns, project cancellations, curbs on exports, even nationwide lock-downs to prevent further spread of the virus.

Amidst fears that the sudden lock-down and disruption in trade cycles could lead to substantial losses in the financials of even the bluechip stocks, there has been rampant selling of stocks all around the world. Even the US market, Dow Jones (DJIA) wasn’t spared from this selloff as it has corrected nearly 25% in the last few weeks and entered into a ‘Bear Market’ phase for the 1st time since the Global Financial Crisis (2008). Though the POTUS’ declaration of COVID-19 as a ‘National Emergency’ brought temporary relief to the US markets to recover almost Thursday’s entire loss, the DJIA futures (16th March, 2020) hit the lower circuit (5%) and had to be halted to prevent further selloff.

Late night, 15th March, the US Federal Reserve slashed it’s interest rate to near 0%, touching the Zero Lower Bound for the first time along with issuing a 700 billion USD bond buyback plan. This is being seen as a contingency measure for the worse times yet to come and global markets went into another phase of bear dominance on Monday itself, discounting the short-term economic gloom.

Nifty 50 fell down almost 8% on 16th Mar, 2020, riding on US Fed cut & COVID-19 effects.

Many economists see the Reserve Bank of India (RBI) following in the footsteps of the Fed Reserve and opt for a 25-50 bps rate cut as soon as possible (even before the MPC meeting on 3rd April, 2020) to boost money supply and demand pickup in an economy on the verge of a deepening slowdown. Though this move by the Central Bank may look a prospective one at a glance, however careful analysis may lead to points of failure or ineffectiveness of this hasty decision:

Crude at nearly all-time lows owing to the OPEC-Russia oil price war
  • India, being a major importer of crude, has massive dependence on the price of crude for it’s inflation rates as well as GDP. With crude at nearly all-time lows, the inflation may be expected to be at all time lows and the latest WPI data (16th March, 2020) is in line with this belief as well.
WPI inflation data for India
  • However, there has been a 1312.5% increase in the WPI data from Nov-19 (0.16%) to Mar-20 (2.26%) despite a fall in oil prices. RBI has already reduced the Repo rate by almost 100 bps in the last 12 months, leading to a ‘stable & rising‘, if not rapidly growing, inflation rate in the country. Though India has been in a continuous phase of industrial slowdown, the inflation effect hasn’t helped in raising consumer effect to that extent. A further rate cut could lead to a leap in the CPI & WPI inflation numbers despite near-bottom crude prices.
Repo rate (ST & LT) over the last 12 months (Apr, 19 to Mar, 20)
  • With more cities going into lock-down to prevent mass gatherings, retail, tourism, entertainment and aviation industries have to bear the brunt through brutal losses. Consumers are left with less outlets to spend their money, thereby drying up liquidity and transaction velocities due to less expense mediums.
  • The recent slowdown is hardly due to lack of disposable income in the hands of consumers, more attributable towards shift of consumer sentiment towards a cautionary stance of surviving through the upcoming recession.
  • Lack of consumer interest had brought about slowdown in automobile sector. The virus outbreak extended the sectoral gloom to the entire economy, particularly dragging consumption based sectors like tourism, aviation, fisheries, consumables to a point of no return in the next 1-2 quarters. Unless these industries receive any financial stimulus/package, it will be extremely difficult for them to cope with the recent losses. The government should focus on reviving these industries instead of reducing repo rate any further.
Capital infusion in the Indian stock market by domestic investors (Mar, 2020)
  • As the above DII data suggests, inspite of lack of FII & FPI interest in the high risk Equity segment of the Indian Capital markets and high FII selloffs, there has been a consistent capital infusion by Domestic investors in order to fetch better returns from equities. There is a notion of bottom-out and bounce-back from these lower levels in the near term and hence, Net DII flows have remained consistently positive.
  • In case RBI reduces repo rates any further, deposits and bond yields are likely to fall, making them less attractive options for the domestic investors. With less expense outlets available to a consumer, he/she is likely to divert more savings to the Capital markets with hopes of better ROI. This is likely to improve the Equity markets and strengthen the financial economy of India without having any major effect on the real economy, which will continue to be in the grip of slowdown and recession fears in the next few quarters.