B Prasanna, Group Head – Global Markets, Trading and Research, ICICI Bank, says GDP was a shocker, but he thinks it has bottomed out and is going to improve in the second half. But even after the improvement, ICICI Bank is penciling in a second half GDP of around 6.5% and FY25 GDP growth of 6.3%. These are good numbers, but much less than what they were expecting and even what RBI was expecting at the beginning of the year upwards of 7%.
Prasanna says a CRR cut would be a far more important move to enable banks to start lending, especially to the small and medium businesses. He says Q2 GDP was a game changer for RBI but he expects them not to cut rates in the December policy; they will probably cut CRR by 50 bps, maybe in two instalments of 25 bps each over the next two or three fortnights, they will also talk dovish.
We have seen the slowest GDP growth print in the last seven quarters. Should one really be reading into this print with a microscope and should we be worried?
B Prasanna: It was a shocker of a GDP growth number. To be fair, most of us expected a slowdown in the Q2 GDP numbers based on the high frequency indicators which have been coming in the months of July, August, and September and we were kind of prepared for a slowdown. But 5.4 was something that none of the people in the street kind of expected. It is at least 100, 110 basis points lower than what the consensus estimate was.
The driver of this slowdown was slower government spending, which we knew was there in the Q1, but in Q2 as well, there has been a slower government spending and the one that worried us is about the growth in manufacturing, especially mining and the electricity demand which has taken a hit. Add to that, the consumption slowdown that we were seeing, so it looks like a bit of investment as well as a bit of consumption, has slowed down leading to this kind of a number.
Now, many reasons can be attributed to it. Some of the obvious ones are the fact that rainfall intensity was very high and the government really did not spend as much. But there are also some other subtle reasons like the tightness in liquidity that RBI had been indirectly gaming for three-four months prior to this period and the credit growth moderation and the macro-prudential norms that they have been driving at and to some extent, maybe a long-term reason is the post COVID spending splurge also coming down.
So, net-net, the GDP was a shocker, but we think it has bottomed out and is going to improve in the second half. But even after the improvement, we pencil in a second half GDP of around 6.5% and FY25 GDP growth of 6.3%. So, these are good numbers, but these are much less than what we were expecting and even what RBI was expecting at the beginning of the year upwards of 7%. So, there is a revision lower to the extent of 50 to 70 basis points for the year.
The general view is that the government knows spending has slowed down and would work on it. But that is easier said than done. We are talking about government order coming out, government spending to pick up, order execution to start, the multiplier to kick in. While the intention and ambition of the government is to increase and pump prime the economy, do you think in reality it is not going to be at a very fast pace?
B Prasanna: No, they really did have a problem in the first three months and the first six months on account of election and election-related uncertainties. So, in order to align with the Budget target, maybe they would not be able to achieve the entire target, but even if you assume 90% to 95% of the capital spending were to be achieved, they have to show a humongous growth in the months of December, January, February, and March. So, it is going to be a tough ask for them.
But I feel that from the last six months on a sequential basis, there is going to be a substantial increase in government spending. But having said that, it seems to me that the main two stories of this phenomenal GDP growth that we have seen in the last two years is one is the government spending and the capital expenditure, infrastructure spending that they are doing and the second is the real estate revival that is truly on and still continuing.
Outside of these two, there are some areas of concern in consumption. The private sector, which was expected to take up the cudgel when the government slowed down, clearly has not yet taken it up and there are worries on urban consumption as well while rural consumption might get better going forward. All in all, it is a different kind of a mix. But like I said, the worst seems to be over and we expect the pickup to happen. But the pickup cannot be so much that what is lost in the first half can be compensated in the second half.
So, then what is your expectation as to what RBI should do? In the coming MPC meeting at the end of this week, will they blink first, bite the bullet, and call for a rate cut, or stay the course?
B Prasanna: I think the Q2 GDP is a game changer from the Reserve Bank perspective. The focus has been completely on managing inflation. They will have to start shifting to managing growth without compromising on inflation, and that is the way they will probably look at the priorities going forward. But unfortunately, this number alone is not going to be enough for the RBI to go the whole hog in terms of cutting rates, they have to wait for inflation to settle down, especially after so many concerns that have been spoken about the governor, where he has spoken about the need for inflation to be sustainably at 4% and the need for patience.
So, it will be a bit of a credibility issue if the RBI changes stance wholeheartedly. There are two things they can do – one is that the expected inflation itself can come down because of the fact that GDP is now far lower than what we earlier thought and that can lead to the inflation estimate of RBI coming down and bear in mind that policy is normally based on expected inflation and not necessarily on current inflation. So, even while current inflation is not at 4%, expected inflation can be brought down to 4% based on genuine data modelling. So, that is one of the most important things that can be done.
The second thing is, repo rate cut is not necessarily the only thing. RBI has been having the CRR at higher than pre-COVID levels of 4%. It is at 4.5% and that extra half a percent is something that was done during the post COVID tightening that they did and that is something that can definitely cut down and the other thing they can do is to talk a little bit more dovish.
I expect them not to cut rates into the December policy, they will probably cut CRR by 50 basis points, maybe in two instalments of 25 basis points each over the next two or three fortnights, but they will also talk dovish, indicating that there could be a rate cut in the offing in February, especially if we expect food inflation to come down and headline inflation to be around 5%. They might be able to cut because the expected inflation would still be down to 4%.
The reality is that liquidity is tight. RBI will have its own numbers to defend every time we make a tight liquidity argument, the bottom of the pyramid is not getting the credit which they want. NBFCs are feeling choked up and in general, for MSMEs, it is not an easy cakewalk for the bottom of the pyramid and getting fresh bank loans is a problem. It is not about half a bps here or half a bps there. Even if rates go down, there has to be willingness to lend.
B Prasanna: No, that is why I am making a point. There is a clear difference between a repo rate reduction and a liquidity injection by way of a CRR cut. A repo rate reduction keeps the amount of money in the system constant, but tries to reduce the price of liquidity. There, your angle of the small and medium businesses, whether they get the benefit of a lower interest rate, you can question it. But when you start reducing CRR and infusing base money into the system, that actually leads to more money at the hands of the banking system and there, the argument would be that they would be more inclined to lend at some point of time when the liquidity is there.
Also, beyond liquidity tightness, beyond all these, RBI has also been wanting the banking system to slow down and bring down the credit deposit wedge and that is playing out. The credit growth was much higher than deposit growth five-six months ago. Today, the credit growth is far lower than deposit growth so that has played out. So, beyond a few specific sectors that RBI would still be mindful of and keep the macroprudential concerns on. Beyond that, the overall pull to bring down credit growth of the banking system, emanating from RBI can slow down. From all these perspectives, a CRR cut would be a far more important move to enable banks to start lending, especially to the small and medium businesses that you are talking about.
