MPC Take 2: New Committee, Old Problems

The Friday, when India’s Monetary Policy Committee presents its latest review, the likelihood of any change in interest rates is low. Just like at the time of the August meet.

What’s to look forward to on Friday then? A reconstituted panel and its view on the shape of India’s recovery from the Covid-19 crisis.

On Monday, the government appointed Ashima Goyal, Jayanth R Varma and Shashanka Bhide as the three external members to the panel for a four-year period. Immediately after, the central bank announced that the once-delayed meeting of the MPC will take place within days of the new members being handed their appointment letters.

Before the MPC was rescheduled, a Bloomberg poll of 32 economists showed that 30 expected a status quo, while two expected a 15 and a 50-basis-point cut each. While the newly appointed external members may have lent a dovish tilt to the MPC, the committee is still likely to continue to maintain a status quo on Friday, along with retaining its accommodative stance, according to a research note by Nomura dated Oct. 6.

The MPC has already cut rates by 115 basis points since the Covid crisis hit in March, bringing the repo rate down to 4%.

Growth: Weak But Improving

Growth remains the primary concern for the economy.

A near 24% contraction in real Gross Domestic Product in the April-June quarter has prompted economists to predict a near double-digit contraction for the Indian economy in FY21.

High-frequency indicators, however, have improved in recent readings.

Manufacturing Purchasing Managers Index surged to the highest in over eight years in September. Services PMI improved to 49.8 last month compared with 41.8 in August. E-way bill collections and electricity generation have exceeded pre-Covid levels.

Goods and services tax collections, exports, manufacturing PMI, electricity and E-way bills are all pointing towards a steady improvement in economic activity, said Sameer Narang, chief economist at Bank of Baroda. "As more sectors are unlocked in the coming months, we see further improvement in economic momentum," he said.

Inflation Remains Sticky

Despite marginally easing in August, retail inflation remained above the MPC’s target for the fifth consecutive month. Consumer Price Index inflation was at 6.69% in August compared to a revised estimate of 6.73% in July, according to data released by the Ministry of Statistics and Programme Implementation.

However, after three successive quarters of above-target inflation, there are signs that inflation has peaked, said Rahul Bajoria, chief India economist at Barclays. Favourable base effects, the government's supply-chain management and a reversal in commodity prices will likely have a moderating effect on CPI inflation over the coming months, he said.

Inflation data for September will be released on Monday.

Interest Rate Transmission

The Weighted Average Lending Rate for all banks stood at 8.35% in August compared to 9.36% in January this year, RBI data showed. In the bond market, too, there has been a large decline in both sovereign and corporate bond yields, said Narang. The spread of corporate bonds over government bonds has seen a sharp reduction.

RBI also changed the extent of liquidity in the system through its Targeted Long Term Repo Operations/Cash Reserve Ratio cut/ Open Market Operations and forex intervention, he said. With an accommodative stance, we expect liquidity surplus to continue which will favour further transmission in the coming months, Narang said.

Growth, Inflation Outlook Key

While the growth-inflation mix may prompt a status quo in rates, the central bank’s own projections will be watched.

The RBI has not provided a post-Covid assessment of growth and inflation but is likely to do so this time. The central bank is required to publish the Monetary Policy Report twice a year, which contains sources of inflation and forecast of inflation for 6-18 months ahead, said Narang. As such, the projections on inflation are likely to be released along with the report.

The projections will give a sense of the uncertainty band surrounding the near-term outlook, said Kaushik Das, Chief Economist at Deutsche Bank. There is also a likelihood that the RBI will possibly provide growth estimates too in the next policy, now that the April-June 2020 GDP data is already out, he said.