RBI axes GDP guidance on fears of slump in global economic growth

Reserve Bank of India (RBI) has trimmed its earlier outlook for the gross domestic product (GDP) growth and consumer price index (CPI) inflation in its first monetary policy for the current fiscal announced on Thursday.

With the base effect wearing off and a reversal in food and fuel prices, the apex bank cut inflation forecast for the fourth quarter of the last fiscal to 2.4% from the earlier 2.8%.

It also slashed its inflation projection for the first half of the current fiscal to 2.9-3% from 3.2-3.4%. The central bank had predicted retail inflation to come in at 3.9% in the third quarter of FY20. However, in its latest policy review, it said the second half of this fiscal could see inflation in the range of 3.5-3.8%.

The RBI has also lowered its GDP guidance for FY20 to 7.2% from 7.4% due to weakening global economic growth and slower pick-up in the domestic investment activity.

In February, it had projected the economy to grow in the range of 7.2-7.4% in the first half of the current fiscal. It now expects growth during that period to be at 6.8-7.1%. For the second half, it is predicting GDP growth to rebound at 7.3-7.4%. The central bank's earlier estimate for economic growth in the third quarter of FY20 was 7.5%.

Enumerating the reasons for a downward revision in the GDP growth, an RBI note stated, "There are some signs of domestic investment activity weakening as reflected in a slowdown in production and imports of capital goods. The moderation of growth in the global economy might impact India's exports".

The central bank's outlook on GDP growth for FY20 is slightly higher than the Central Statistical Office's (CSO) second advance estimate of 7%. Asian Development Bank (ADB) has also predicted the Indian economy will grow at 7.2% in FY20. It recently cut its earlier forecast of 7.3% for FY19 to 7.1% due to global demand slowdown and revenue shortfall. For a second time, Fitch Ratings lowered its projection for the current fiscal to 6.8% from 7.1%. Earlier in December, it had forecast a 7.3% growth.

International Monetary Fund (IMF) and World Bank have forecast a high growth rate of 7.5% for FY20.

For the fourth quarter of FY19, RBI expects the real GDP to "recover" to 7.5% from 6.6% in the third quarter.

"Taking into account the baseline assumptions, survey indicators, the cut in the policy repo rate in the February 2019 policy and model forecasts, real GDP growth is projected to improve from 7% in 2018-19 to 7.2% in 2019-20 – 6.8% in Q1, 7.1% in Q2, 7.3% in Q3, and 7.4% in Q4 – with risks evenly balanced around this baseline path. For 2020-21, the structural model estimates indicate real GDP growth at 7.4%, with quarterly growth rates in the range of 7.3-7.5%, assuming a normal monsoon, and no major exogenous or policy shocks," said the RBI note.

Madan Sabnavis, chief economist, CARE Ratings Ltd, believes RBI's forecast is "fairly conservative in its inflation outlook" as it underplays the impact of base effect and prediction of poor monsoon this year. He estimates inflation number to "move toward the 4%-mark and probably even cross 4%".

"In terms of food inflation, we have already been seeing the numbers increasing, especially of vegetables and pulses. Combine this with the possibility of monsoon not being normal. They could be severe in the Deccan plateau area. We have already witnessed a drought-like situation in the interiors of Maharashtra, Telangana and Andhra Pradesh, which has pushed the food prices in the current year. Reservoir levels are at an all-time low in these regions. Therefore, there is an imminent threat of food prices going up. This kind of reversal is what makes us believe that inflation number will move towards the 4% mark, and probably cross 4%," said CARE economist.

Sabnavis pointed out that the RBI has completely overlooked the demand-pull inflation that could play out were the opposition to come power. The main opposition of the government – Congress –recently published its manifesto which if effectively implemented could spur spending in the economy.

"Suppose, we have the opposition coming to power, they are talking of Rs 72,000 minimum income direct transfer to the poorest households. It definitely is a lot of spending power which can push a demand-pull inflation which is currently not there. Today, all the inflation threats we have are more on the cost-side or the supply-side," he said.

CARE Ratings has guided a 6.9% GDP growth for FY19 and 7.1% in FY20. "Nobody is expecting the economy to recover in a significant way because we are not seeing investment picking up or consumption improving in a big way. Investment is coming only from the government, and therefore, there is only limited buoyancy in the economy".

D K Srivastava, chief policy advisor, EY India, thinks otherwise. He said fiscal and monetary stimulus provided to the economy through front-loaded government spending and bank rate cuts of 50 basis points in the last two monetary policy is likely to push growth.

"Downside risks (to RBI's GDP growth outlook) are minimal because there is a stimulus that is now being given through both monetary and fiscal sides. On the monetary side, we have the 25 basis point reduction (plus 25 basis point in the last monetary policy) and on the fiscal side the new financial year has started and elections are still happening, so front-loaded expenditure by both central and state governments is expected. So there is a stimulus coming into the economy, which should enable us to achieve 7.2%-plus GDP growth in FY20," he said.

Srivastava said if the inflation were to move upwards due to global crude prices, it would push nominal GDP growth to around 14%.

The RBI's policy review notes that were El Nino scare to result in poor monsoon, it could lift inflation by 50 basis points. Another upside risk to inflation was the international crude price, which has of late been creeping up due to supply issues and geopolitical factors. It expects CPI inflation to climb up to 4% in FY21.