MPC Meet: ‘Temporary Pause’ In Rates May Extend Into Next Fiscal Year

India’s Monetary Policy Committee will announce its final review for 2019-20 on Thursday, days after the Union Budget tried to strike a difficult balance between treading a prudent fiscal path and supporting growth.

While fiscal policy will be a key discussion point for the committee, it will be the recent spike in inflation that will likely seal the case for a status quo on rates. The MPC, after cutting its benchmark repo rate by 135 basis points in 2019, left rates unchanged at 5.15 percent when it met last in December. It, however, retained an accommodative stance and Reserve Bank of India governor Shaktikanta Das termed the pause as “temporary.”

The pause will continue for now, according to all 36 economists polled by Bloomberg. Most expect the MPC to also hold on to its accommodative stance, although a few believe that a move to a neutral stance cannot be ruled out if the central bank sees inflation pressures spilling over to segments beyond food.

Meeting The Inflation Objective

The MPC, which has been handed an inflation target of 4 percent, with a tolerance band of +/-2 percent, will take on board the spike in inflation since it last met.

Retail inflation rose to 7.35 percent in December from 5.54 percent in November. This was the highest reading since the committee was constituted and well above the 6 percent upper limit of the tolerance band. The surge in inflation was led by a 12.6 percent rise in food and beverage inflation. Apart from vegetables, other food items, such as cereals, meat, fish, milk and milk products, are also seeing higher prices.

Prachi Mishra, chief India economist at Goldman Sachs also expects a status quo due to rising inflation pressures. While unlikely, she doesn’t rule out a change in stance from accommodative to neutral if inflation becomes broad-based.

If the uncertainty around inflation gets more magnified, a neutral stance would give the central bank a window to move in either direction, she explained, adding that the bar for raising rates would still be very high.

Growth Stability; Fiscal Support

While growth remains weak, the incoming data between the December and February policies has suggested that the economy is stabilising.

The Markit India PMI Manufacturing Index rose to an eight-year high of 55.3 in January 2020. The eight core infrastructure industries saw output rise by 1.3 percent in December after a four month long contraction. Coal output rose 6.1 percent, while cement output increased 5.5 percent.

The eight industries make up 40 percent of the Index of Industrial Production. That broader index, too, has shown signs of revival, rising 1.8 percent in November after having contracted for the past three months.

As such, the committee may not see any immediate need to cut rates based on the evolving growth picture. The RBI may also feel that it has front-loaded interest rate cuts to support growth and look for continued transmission of those rate cuts.

In addition, while the central government has budgeted to bring down its headline fiscal deficit to 3.5 percent in FY21 from 3.8 percent in FY20, some economists believe the ‘fiscal impulse’ is positive and supportive of growth.

As such, the MPC may wait for the inflation outlook to evolve before it decided on further rate action. The space for that action may be limited, said Pranjul Bhandari, chief India economist at HSBC.

“We expect inflation to fall to near 4.5 percent by mid-2020, opening up some room for a final 25 basis point rate cut by the Reserve Bank of India, taking the repo rate to 4.9 percent,” Bhandari wrote in a report on Monday.

Uncertain Global Picture

While domestic growth-inflation dynamics may not leave much space for further monetary policy action, the disruption caused my the outbreak of the Coronavirus may hurt growth in the regional and global economy.

This, according to Jahangir Aziz, head of emerging market economics at JPMorgan, could lead to disinflationary pressures and scope for easier monetary policy globally and in India.

Aziz added that while rising headline inflation in India may not present the right optics for interest rate cuts, once the elevated food inflation eases, there should be room for more rate cuts than what the market is expecting.

Unconventional Monetary Policy

Since the last MPC meet, the RBI has announced ‘operation twist’, under which the central bank buys long term bonds and sells shorter dated securities. The move, while being liquidity neutral, helps flatten the yield curve by bringing down long term rates and pushing up short term rates.

Operation Twist is an admission of two things, said Arvind Chari, head of fixed income at Quantum Advisors. “First, the RBI does not see a deep rate cutting cycle from the current repo rate level of 5.15 percent and any rate cut will be delayed. Second, the government is certain to breach the fiscal deficit and hence the bond market will require support to manage the spike in bond yields,” Chari wrote in a note on Tuesday.

“So, the most important cue from this MPC meeting would be on what the RBI Governor mentions as the rationale for undertaking ‘Operation Twist’,” he said.