Monetary Policy: What To Track When The MPC Meets On Friday

The Monetary Policy Committee meets on Friday amid a number of concerns⁠—some that it must address directly and others that the Reserve Bank of India must deal with outside the purview of the committee.

Growth remains weak, demand-driven inflation is modest and confidence — in the prospects of the economy and its banking backbone — is low. Against this backdrop, the committee must continue to try and stabilise the economy while the RBI, in its role as the banking regulator, must dispel any fears of instability of the banking system.

Here’s what BloombergQuint will be watching for within the MPC statement and the following statement by RBI Governor Shaktikanta Das.

Another Cut But By How Much

The MPC last met in August. Since then the GDP data has told us that the economy is weaker than most feared. Even after GDP growth printed at 5 percent in the first quarter, economists are not certain that we have hit a bottom. Confidence, at least in the first two months of the July-September quarter was low, high frequency indicators showed no major bump ups.

So another cut in the repo rate seems like a given.

But by how much?

Last time the MPC surprised with a 35-basis-point cut so, frankly, they could cut by any quantum. Most economists are predicting 25 basis points. Some feel they may do a 40-basis-point cut to convey the urgency that many feel has been missing in the MPC’s actions so far.

Last time, when Governor Das said a “50-basis-point cut was too much”, he ended up spooking the market, which saw it as a signal of limited scope for further cuts. He will likely be more careful this time in what he signals beyond Friday’s rate cut.

If they do 25 basis points, Das will likely give clear indications that further rate cuts are coming. If they cut by 40 basis points, watch for clues on how low he thinks rates can go from here. Can the repo rate fall as far as 4.75-4.5 percent?

What’s The RBI’s Growth Estimate?

Contrary to its conservative credentials, the RBI’s growth estimate is currently the most optimistic among forecasters. The RBI expects growth at 6.9 percent in FY20. Few agree. Question is how much will the RBI cut its growth estimate by?

The central bank missed a chance to peg down its estimate at the last meeting. Perhaps it felt that a sharp cut will send the wrong message out to the economy. Or perhaps its models were genuinely predicting a sharp recovery.

Will it change its view this time?

It would be tough not to. A growth estimate closer to 6.5 percent is likely but even that will seem optimistic against the current environment. Should growth undershoot the RBI’s estimates, it will be second year that this has happened.

So watch what the central bank’s growth estimate is and their analysis. They have so far shunned most suggestions that the slowdown is structural, although in the annual report released in August, they did admit that structural reforms are needed to push up growth closer to potential.

What About Inflation And Fiscal Risks?

Inflation remains below the MPC’s range of 4 (+/-2) percent. It’s not a worry at this point. Even if headline inflation moves closer to 4 percent because of some pick-up in urban food inflation, the MPC has room to keep it on the back-burner for now. Remember, India has a flexible inflation target and if the MPC needs to focus on growth for some time, it can do so.

It will be more interesting to watch what the MPC says on fiscal risks. Last time’s statement stayed away from making any comments, although there was healthy debate within the committee which was reflected in the MPC minutes. This time, will the government’s corporate tax cuts find their way into the MPC statement?

And will RBI Governor Das comment on whether he sees a risk of fiscal slippage just on account of weaker growth and tax revenues this year.

Bond Markets: It’s All About The Word ‘Neutral’

Bond markets are in a sulk. A liquidity review undertaken by the RBI did not give them what they want. They wanted the liquidity stance to move with the monetary policy stance. Instead, the RBI stuck to its guns and said the liquidity should be in slight deficit “unless financial conditions warrant.”

That’s got the bond market watching out for the word “neutral” again.

Will Governor Das assure that liquidity will be maintained close to neutral in the current scenario?

At present, liquidity is comfortable but the bond markets are looking for an assurance that the RBI will do what it needs to keep liquidity close to neutral and not allow it to slip into deficit again.

The Elephant In The Room

The big question — this one for the RBI to address — is why there have been so many skeletons falling out of the financial sector closet.

First it was under-reporting of bad loans by scheduled commercial banks, then an unanticipated asset-liability mismatch at non-bank lenders plus instances of mis-governance at large NBFCs. And now, Punjab and Maharashtra Cooperative Bank, a relatively large cooperative bank gets, placed under directions after it emerges that a large industrial house was allegedly too close to the bank.

Why did the RBI’s supervisory functions miss all this? And what is the regulator doing to strengthen supervision? Governor Das has already said that a new supervisory cadre is being set up but that is a long term fix. Is the RBI doing anything in the interim to strengthen scrutiny?

The RBI’s top brass may want to give some answers that puts nervous minds at rest.