Oil prices, rupee value & fiscal slippage cut affect future repo rate cuts

While the stock market is cheering the cut in corporate tax rates, the fourth bi-monthly monetary policy review due on October 4 is likely to see a trinity of crude oil prices, weakening rupee and fiscal slippages coming in way of larger doses of repo rate cuts to support the growth momentum. The repo rate, at which banks borrow funds from the Reserve Bank of India (RBI) has already been cut by 110 basis points to 5.4 per cent since January this year.

There are expectations of another 25 basis points cut on October 4, but the final decision would be of six wise men that sit on the monetary policy committee (MPC). It has three external members - Chetan Ghate, Professor, Indian Statistical Institute; Pami Dua, Director, Delhi School of Economics and Ravindra Dholakia former professor at Indian Institute of Management, Ahmedabad. The remaining three are from RBI - Michael Patra, Executive Director; B P Kanungo Deputy Governor and Governor Shaktikanta Das. The governor also has a casting vote in case of a tie.

In the past external MPC members have strongly raised the issue of crude oil prices, rupee depreciation and fiscal slippages. In the coming meeting these issues are likely to come up. Take a look;

The drone attack on Saudi Arabian oil plants led to crude oil prices rising from $60 per barrel to $69 in a few days. It has since settled at around $65 per barrel. "If there is assurance supplies will remain normal, prices will remain stable or can be driven up. While up to $70 per barrel can be considered tolerable, anything above can be a disruption for the world economy," says Madan Sabnavis, chief economist at Care Ratings Ltd.

In August, Pami Dua highlighted the volatility in international oil prices. Ravindra Dholakia in June was hopeful oil prices won't breach the $58-$73 per barrel band in the near future. He was then of the view that oil prices may not be a major cause of worry for domestic inflation till it breaches $80-85 per barrel. There are now estimates of oil reaching $75-80 a barrel which was not on radar few months ago.

Even if oil is at $65 per barrel, there is the danger of higher domestic oil prices coming from rupee depreciation against the US dollar. The rupee has weakened from 69 a dollar to 72. The rupee was largely stabilized few months ago. In June MPC review Chetan Ghate talked about currency risk as Indian rupee depreciated more than emerging market currencies over a year. "I continue to remain watchful of the risk that the rupee and crude will have on inflation excluding food and fuel," he said.

Some defend saying the rupee would bounce back post the corporate tax cuts. The stock market is already seeing portfolio investors coming back to the stock market. The new inflows would reduce the current account deficit (CAD) and help contain the rupee slide. But the future risk to rupee comes from escalating trade and currency war between the US and China.

There are new worries on the fiscal deficit front. The tax cuts announced by the finance minister would result in a revenue loss of Rs 1.45 lakh crore in 2019-20. It is estimated the fiscal deficit will slip from the budgeted 3.3 per cent of GDP to 3.7-4 per cent. The higher fiscal deficit would be inflationary. In addition, borrowings through public sector companies have been on the rise. These borrowings are now 8.9 per cent of GDP. Ghate has said these borrowings would lead to detrimental outcomes for the economy.

Former RBI Deputy Governor Viral Acharya had said that such borrowings impair monetary policy transmission due to crowding out effects on market financing through public bonds and on bank deposits through small savings which continue to offer rates that are significantly higher than market yields. "This channel bites particularly when the domestic savings rate is on a decline and increases economy's reliance on external sources of funding," said Acharya.

In the past Dholakia was of the view that fiscal deficit slippages on account of revenue shortages (on the back of falling nominal GDP) are not genuine fiscal slippages. He is of the view that genuine fiscal slippages are those that happens because of higher capital expenditure. Surely there is lot for the MPC to debate on before deciding the next course of action for interest rates.

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