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Informist, Friday, Jan. 24, 2025

 

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--Nomura's Sonal Varma: MPC must cut repo rate in Feb to support growth
--CONTEXT: Nomura Chief India Economist Sonal Varma's comments in interview
--Nomura's Sonal Varma: Expect MPC to lower repo rate by 25 bps in Feb meet
--Nomura's Sonal Varma: Monetary policy can't be hostage to currency pressure
--Nomura's Sonal Varma: See Jan CPI at 4.5% vs 5.2?c on lower food prices
--Nomura Varma: Inflation headed dn; question remains over recovery in growth
--Nomura Varma: Fiscal policy should support growth in targeted manner
--Nomura Varma: Fiscal room limited to support growth as public debt high
 

 

By Shubham Rana and Priyasmita Dutta

 

NEW DELHI - The recent decline in the rupee may have increased the challenges for the Reserve Bank of India's Monetary Policy Committee to ease interest rates, but the rate-setting panel must lower repo rate in February to support slowing economic growth as monetary policy cannot be held hostage to the currency, according to Sonal Varma, chief economist, India and Asia ex-Japan at Nomura.

 

"India has faced currency pressures in the past, but things are so different today," Varma told Informist in an interview. "Our current account deficit is less than 2% of GDP, inflation is extremely benign and not around 9-10% as was the case 12-13 years back. So things fundamentally are actually strong. So we just need to tide over, let the adjustment happen which we prevented from happening," she said.

 

Varma expects the MPC to lower the repo rate by 25 basis points in February, though some economists have said that the pressure on the rupee in the recent weeks could force the panel to leave the rate unchanged at 6.50%. The rupee has depreciated 2.5% against the dollar since October end, and has fallen 0.7% in January so far. To put this recent decline into context, the rupee fell just 1% in the 12 months ended October.

 

Varma estimates that for every 5?preciation in the rupee against the dollar, CPI inflation rises by around 30 bps, which would be manageable right now. Nomura expects CPI inflation to moderate to around 4.5% in January from a four-month low of 5.2% in December as prices of vegetables and pulses cool down. The Japan-based financial services group expects inflation to moderate to 4.0-4.5% in 2025-26 (Apr-Mar) from the RBI's projection of 4.8% in FY25.

 

Varma said that inflation is headed lower but the question over a recovery in growth remains. She said GDP growth could be near 6.2% in Oct-Dec, well below the RBI's forecast of 6.8%. Growth in the economy fell to a seven-quarter low of 5.4% in Jul-Sept. The government has projected India's GDP growth to slow down to a four-year low of 6.4% in FY25. "You have a tight macro potential, tight liquidity, restrictive monetary policy. You need some levers to support growth," Varma said. "Obviously, the currency bit has made it a lot more challenging."

 

In order to fuel a recovery in growth, monetary policy needs to "at least be neutral" whereas fiscal policy should support growth in a targeted manner while focussing on fiscal consolidation, the economist said.

 

BUDGET SUPPORT

The government will have to do its part in starting a growth recovery by providing targeted support to the economy, Varma said. She suggested that the government should raise capital expenditure next year after it is likely to fall short on the FY25 budgeted target.

 

"So the first thing is to still ensure that capex (capital expenditure) as a share of GDP remains relatively high because we are in an environment where private investment still remains very sluggish, exports are unlikely to be a major growth engine, and urban consumption is facing growth challenges," Varma said. "So in that backdrop, you do need some countercyclical policy support."

 

Nomura expects the government to spend only INR 9.5 trillion as capital expenditure in the current year against the budgeted INR 11.1 trillion. Next year, Nomura projects capital expenditure to rise to INR 10.7 trillion.

 

Apart from capital expenditure, the government can also provide income tax support for households in the lower tax bracket because the propensity to consume tends to be much higher in that bracket, Varma said, adding that more people need to be moved to the new income tax regime.

 

The other support to the Indian economy that the Budget can provide is to "design incentive structures" for protecting "infant industries" to ensure local value addition and integrating them into global value chains, Varma said. Besides, the government can also look into the high tariffs on some intermediate goods to make the final product more cost competitive.

 

FISCAL PRUDENCE?

Though many economists believe the government has fiscal room to leverage spending in FY26 in a bid to support growth, Varma has her doubts. "If your currency is under pressure and you have a consolidated deficit of above 7% of GDP and the starting point is a public debt of 85% of GDP, your degrees of freedom are limited," she said. Though India may end with an improved fiscal deficit compared to the budgeted 4.9% of GDP in FY25, much of the fiscal consolidation in India in general happens due to high growth.

 

The government has reined in fiscal deficit from the record-high of 9.2% of GDP during the COVID year to 5.6% in FY24. This consolidation, Varma said, did not compromise India's growth because it was largely through revenue buoyancy and not subdued spending. "I think we've made sure that the quality of consolidation that we're doing is good," she said.

 

The government has announced that it aims to keep the fiscal deficit below 4.5% in FY26 and then target reduction in the debt-to-GDP ratio from FY27. This, she said, does give the government more "flexibility, but is also driven by dynamics that are not entirely in your (the government's) control." Three such factors are the nominal GDP growth, interest rate costs and the kind of growth shocks in a particular year, she said.

 

Varma said the framework targeting the debt-to-GDP ratio is easier to communicate to the rating agencies which focus on it. But communicating the same to markets is much more complex. The FY26 Budget will have to communicate "better" and signal that the "idea is not to derail fiscal prudence at all and that the path is still going to be towards spending on the right things and ensuring that there is more transparency."  End

 

Edited by Vandana Hingorani

 

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