Capex, job creation crucial to sustain long-term growth: IDFC FIRST Bank chief economist

In an exclusive interview with The Federal, IDFC FIRST Bank chief economist Gaura Sen Gupta delves into the Reserve Bank of India's (RBI) recent policy shift, which saw the key interest rate reduced to 6 per cent and the stance changed to accommodative. Sen Gupta explains how falling inflation and improved liquidity conditions have enabled this move, with rate cuts now gaining traction across the broader economy.

While acknowledging external challenges, such as global tariffs and slowing growth, Sen Gupta stresses the critical need for structural reforms in agriculture and capital expenditure to sustain long-term economic growth.

Edited excerpts:

The RBI has once again reduced rates to 6 per cent, a move that was widely anticipated by the markets. In addition, there’s a shift in stance from neutral to accommodative. What are your initial thoughts on this change?

The rate cut was widely expected, driven by domestic factors, particularly as inflation has now fallen below the target rate of 4 per cent. This has created space for easing policy rates. The change in stance, however, was a close call, especially after the tariff escalation. Initially, a neutral stance seemed more likely.

Also Read: RBI cuts repo rate again: Signal for growth amid global headwinds

The RBI governor provided clarity on how the MPC is viewing the stance. Essentially, the accommodative stance indicates that rate hikes are off the table, with the focus now on rate cuts or a pause. He also reiterated the de-linking of the stance from liquidity conditions, a move previously highlighted by former deputy governor of RBI, Dr Michael Patra.

Additionally, the governor provided further insights into liquidity and transmission mechanisms, outlining how they plan to enhance the effectiveness of these rate cuts on the broader economy.

We don't see banks transmitting these cuts to the customers, except a few, considering the absence of broad-based reduction in both weighted average deposit rate and the marginal cost of lending rate.

The transmission of rate cuts has already begun, starting in April. Bulk deposit rates across the banking system have started to decline. While it took some time for the February policy rate cuts to be transmitted, this was largely due to the credit-to-deposit ratio being skewed, with credit growth outpacing deposit growth for some time. This created competition among banks to mobilise deposits.

The situation has improved recently, with greater clarity on how the RBI will maintain liquidity conditions. Since December, we've seen some changes, and by March, there was more visibility on liquidity infusion from the RBI. They've already infused around Rs 6.4 trillion into the system, with additional open market operations (OMO) purchases scheduled for April. This increased liquidity is expected to support further transmission.

Also Read: What RBI's shift in MPC stance from neutral to accommodative means

Looking ahead, system liquidity is expected to remain comfortable, with estimates suggesting a surplus of around Rs 2 to Rs 3 trillion by mid-2025. This consistent surplus liquidity will help ease transmission. For instance, the RBI’s dividend, expected to be credited to the government in May, will further enhance liquidity, supporting both government expenditure and overall economic activity.

The RBI aims to maintain system liquidity at around 1 per cent of NDTL (net demand and time liabilities), which is roughly Rs 2.6 trillion. This will be achieved through further liquidity infusions, including at least Rs 4 trillion more in FY26. These efforts are expected to maintain a stable environment for deposit growth and support the transmission of rate cuts.

Additionally, the RBI's balance sheet expansion, which had slowed last year, is now picking up, providing further positive momentum for deposit growth and, consequently, for transmission.

With everyone talking about Trump's tariffs and growing global uncertainties, how do you see these external factors influencing India's monetary policy decisions in the coming months?

The government has already revised its GDP forecast down to 6.5 per cent from 6.7 per cent, largely due to global factors, including the impact of tariffs. These tariffs, especially the 27 per cent on Indian exports, could directly reduce GDP by approximately 0.5 percentage points. So, if the GDP forecast is currently at 6.5 per cent, it could realistically drop closer to 6 per cent due to these external pressures, which may not yet be fully factored into the RBI’s projections.

Looking at global growth assumptions, the RBI has kept its estimate at around 3 per cent for FY26, similar to the previous year. However, there are downside risks to this, particularly if tariffs and slower global growth lead to a deeper slowdown. While India is relatively less exposed to global shocks (with exports to the US only making up 2 per cent of GDP), we could still face some indirect impact, especially if global growth weakens further.

Also Read: India growth story intact; PSU banks, telcos attractive: Market expert

If GDP growth is impacted and drops to 6 per cent due to these external factors, it could extend India’s rate-cut cycle. Currently, the market anticipates two more rate cuts, one in June and another in August. Given the delays in the transmission of previous rate cuts, back-to-back cuts make sense. The tariff situation increases the possibility of an additional rate cut, potentially raising the cumulative rate reduction to three cuts instead of just two. So, while the base case is still two cuts, the external risks could pave the way for a third.

Beyond monetary policy, what structural reforms do you think are critical for ensuring sustained economic expansion?

One sector that needs more support is exports. Given the challenges the export sector is facing, such as the 27 per cent reciprocal tariff and the escalating tensions with the US - which recently imposed a 104 per cent tariff on China - it’s clear that global growth will take a hit. In such a scenario, the export sector will need fiscal support to navigate these difficult conditions.

Another key area is private sector capital expenditure (capex). It has been slow to materialise, largely because if you remove the impact of tariffs and focus on domestic growth, urban consumption has been weakening. Wage growth in the urban sector has slowed down, with real wage growth now hovering around 2 per cent, a stark contrast to the double digits seen in the first half of FY24. This slowdown in wage growth indicates that urban consumption will not be as robust as expected. As a result, private corporate capex has also not recovered, as businesses are hesitant to invest without clear demand visibility. With the current tariff escalation adding further uncertainty around external demand, corporate capex is unlikely to pick up anytime soon.

In such a scenario, the government must continue to step in with spending. The current budget does include an increase in capex expenditure, which is aligned with GDP growth expectations. This is a positive development compared to FY25, which should help maintain momentum.

Also Read: LIVE: Trump pauses tariffs on most nations for 90 days, hikes taxes for China

State governments also play a crucial role, accounting for roughly 50 per cent of government capital expenditure. Last year, however, state government expenditure saw a more significant slowdown compared to the central government. There needs to be a pick-up in state government capex, and if you look at state government budgets, they are indeed projecting an improvement in capital expenditure. But the execution of these plans will be key.

Right now, we are in an environment where people are moving away from globalisation, making it a much tougher external environment for India to sustain its growth and ensure job creation. The focus needs to be on labour-intensive sectors that can create jobs, but it’s not just about job creation - it’s also about ensuring that the workforce is skilled and employable. The ability to upskill and reskill labour will be crucial in addressing the challenges of this new global environment.

From a structural perspective, the primary issue India needs to solve is employment creation. With a growing working-age population for the next 25 years, creating jobs and ensuring that the workforce is equipped with the necessary skills is key to maintaining sustainable economic growth, particularly as global growth slows.

During discussions with analysts, we found that the Production Linked Incentive (PLI) scheme has not significantly boosted job creation in states like Tamil Nadu, as many of the jobs created are highly skilled and limited to a few hundred people. This shift towards more sophisticated production may not generate the widespread job growth expected. Given this, do you think focussing on traditional sectors could provide a more scalable solution for job creation, or should India continue emphasising advanced, high-tech industries despite the challenges? RBI’s recent note highlighted bright prospects for agriculture, citing healthy reservoir levels and robust crop production. Given this, do you see traditional sectors, particularly agriculture, making a comeback as a major source of employment?

That's a very good point, and you're right. It's difficult for the services sector to replace agriculture. Currently, around 40 per cent of India’s workforce is still employed in agriculture, contributing only 12 per cent to GDP. This reveals a productivity issue — the per capita output in agriculture is much lower than in services or manufacturing. While services make up nearly 60 per cent of GDP, they employ far fewer people than agriculture does.

If we can boost agricultural productivity, develop value-added sectors, and improve the per capita output of those working in agriculture, it could be a significant step towards solving employment issues. The services sector, however, requires high skill levels and faces the impact of automation, making it harder to scale up for the broader population.

Also Read: Trump's 104 pc tariff hike on China effective from today amid fears of trade war

One executable strategy could be enhancing the productivity of traditional sectors like agriculture. Additionally, the construction sector plays a vital role as it absorbs many people transitioning from agriculture. Real estate has been an important job creator, especially post-COVID. If that sector slows down, it could impact employment, particularly as urban wage growth is already weakening. While construction cannot absorb people at the same scale as agriculture, it can still provide more jobs than manufacturing or services. Therefore, maintaining support for this sector to prevent a slowdown could be one of the immediate actions to address job creation.