Fresh stimulus will have limited impact on demand
After dragging its heels for several months, the Finance Ministry announced further stimulus this week with a package worth INR730bn (0.4% of GDP). Around half of this consists of cash vouchers and loan guarantees for government employees. The other half is aimed at boosting capital spending through interest free loans for state goverments and an increase in funding at the national level.
These measures will help to limit the downside risks to household consumption and investment, both of which have been struggling to recover despite the scaling back of containment measures in recent months. (The capital goods production data for August were consistent with a drop in investment of 15% y/y in Q3.)
But the latest fiscal response is still nowhere near large enough to boost the flailing economy. Take up of low-cost loans to government employees and state goverments is not guaranteed. The other measures should directly boost aggregate demand but are worth only INR530bn (0.3% of GDP). In all, demand-boosting measures in response to COVID-19 now stand at about 2% of GDP, still far smaller than in most other major economies. (See Chart 1.)
Chart 1: Direct Fiscal Responses to COVID-19*
Source: Capital Economics
The Finance Ministry’s tepid fiscal response at the start of the crisis had already guaranteed lasting damage to household incomes and corporate balance sheets. And with the latest fiscal package not doing much to move the needle, we continue to expect the economic recovery to be slow and fitful.
Next rate cut now more likely in February
This week’s CPI and WPI inflation data for September showed a greater rise in price pressures than had been expected, largely due to another jump in food inflation. Daily data suggest that food inflation has dropped so far this month. And a bumper monsoon food harvest and only small increases in minimum support prices should help to anchor food inflation over the coming months.
Meanwhile, we still think that the enormous hit to household incomes and collapse in demand will soon cause core inflation to drop. The MPC expressed a similar view at the RBI’s latest policy meeting. It stated that “underlying factors [driving inflation higher] are essentially supply shocks which should dissipate over the ensuing months”, before saying that it will “await the easing of inflationary pressures to use the space available for supporting growth further”.
All of this means that further monetary loosening is still on the table, but it is now unlikely that the RBI will cut rates as soon as December as we had previously expected. We have pushed back our forecast for the next cut to February. In total, we are still forecasting another 50bp of cuts in this cycle, a more dovish view than is currently being priced into financial markets. (See Chart 2.)
Chart 2: Repo Rate (%)
Sources: CEIC, Capital Economics
The week ahead
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Economic Diary & Forecasts
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19th – 23rd
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Core Infrastructure Industries (Sep.)
*m/m(y/y) unless otherwise stated;
Sources: Bloomberg, Capital Economics
Main Economic & Market Forecasts
% y/y unless stated
Current Account (4Q Sum, % of GDP)
Repo Rate† %
Reverse Repo Rate† %
Cash Reserve Ratio† %
10-Yr Government Bond Yield† %
Sources: Bloomberg, CEIC, Capital Economics *Q2; **September; †End of period
Darren Aw, Asia Economist, firstname.lastname@example.org