Pedestrians cross a road in the Yurakucho area of Tokyo, Japan. (Photographer: Noriko Hayashi/Bloomberg)

MPC Meet: How Much Longer In The Goldilocks Zone?


The first bi-monthly Monetary Policy Committee meeting of 2018-19, scheduled for April 4-5, is an important one, coming at the cusp of an impending change in the interest rate cycle and in an uncertain environment where the favourable tailwinds of recent years have largely dissipated.

The MPC will seek to balance caution on inflation with the need to nurture the nascent growth recovery, best expressed by the February 2018 policy statement. While “the deterioration in public finances risks crowding out of private financing and investment, …the nascent recovery needs to be carefully nurtured and growth put on a sustainably higher path through conducive and stable macro-financial management”. In other words, a coordinated approach is needed of monetary, fiscal, trade and industrial policy to sustain growth.

Currently, a large factor in a stable macroeconomy is the global environment, in an unusual situation where a synchronised global recovery is accompanied by significant risks. After the recent hike, the United States Federal Reserve is likely to continue raising its policy interest rate through the year, although the bets of a fourth hike have dissipated.

The widening gap and lags in the tightening actions of the other major global central banks are likely to renew financial markets volatility, which will have implications for the flows of ‘carry-driven’ portfolio capital flows to all emerging markets, including India.

India’s own interest rates have risen sharply over the past nine months, due to a combination of factors, which has been sought to be partially addressed by the lower bond issuance in April-September 2018 (H1FY19) proposed recently.

MPC Meet: How Much Longer In The Goldilocks Zone?

The first was fiscal, which has been partially addressed by the Union Budget. Uncertainty regarding Goods and Services Tax revenues, however, will persist over the next few months till the effects of the e-way reporting and invoice matching begin to get visibility.

Although liquidity had tightened recently, this was expected and is expected to ease again into FY19.

The second was a scare on higher than expected inflation whose path, obviously, will be the strongest determinant of the MPC’s actions and stance. While the CPI inflation prints over the past couple of months have been lower than street expectations, there is still significant uncertainty going forward.

MPC Meet: How Much Longer In The Goldilocks Zone?

The path, however, is likely to be lower than MPC’s forecast range of 5.1–5.6 percent in H1FY19 and 4.5–4.7 percent in H2. Of significant interest are signs that the House Rent Allowance component of the index has shown up to be lower than our expectations, indicating that most state governments have not raised their allowances during the past few months; even if they subsequently progressively raise their allowances over FY19, the effects on the Index are likely to be more diffused than earlier expected. Of course, the government’s intent to procure cereals at a minimum support price that is 50 percent over ‘cost’ is still uncertain. The definition of ‘cost’ remains unclear and is likely to be significantly higher than for kharif 2017.

Globally, crude oil is likely to remain more or less at the current high levels but metals are unlikely to rise much further without significantly denting the ongoing growth recovery. However, India’s balance of payments surplus is likely to be significantly lower than in 2017, potentially exerting a depreciating pressure on the Rupee, which could potentially (i) reduce the attractiveness of total returns from investment in Indian assets, with subsequently lower capital inflows and (ii) reduce the extent of domestic liquidity arising from the need for RBI intervention to prevent a sharp appreciation of the Rupee, potentially having an adverse effect on short-term market interest rates, thereby raising cost of funds for borrowers.

While a sustained growth recovery is likely to improve corporates’ pricing power, prospects and sources for such an improvement remain uncertain.

Our base case for growth in India’s FY19 gross value added growth is around 7.2 percent.
MPC Meet: How Much Longer In The Goldilocks Zone?

Company sales in Q3FY18 had suggested an earnings rebound, which was only partially explained by commodities price rises. Sales had been particularly strong for manufacturing, less for services companies. This was progressively validated by volume indicators like the index of industrial production, which have risen by an average 7.8 percent year on year over November-January, compared to 2.5 percent over April–October. The purchasing managers’ index has also recovered from the pre-GST levels in June–July 2017 to relatively robust growth territory, again more for manufacturing. So has business confidence, evidenced by multiple surveys. Lending for consumer durables is also reportedly strong. But the export and investment engines of manufacturing are still not robust, the ongoing corporate deleveraging is slow, capacity utilisation rates remain stubbornly low and consumer confidence wobbly.

Given this likely ‘Goldilocks’ growth–inflation trade-off, the MPC will likely choose to keep the key policy rates on hold. Even the tone and stance of the statement is likely to remain largely unaltered, despite the last couple of softer inflation data points. It will be interesting to see the voting patterns, if the sole rate hike vote is maintained or brought back to hold, and if the erstwhile rate cut vote reverts back from the hold in the February meeting. Equally important will be any change to the MPC’s economic forecasts, as a signal of their thinking on economic equilibrium and the level of neutral rates.

Two important decisions might also be actioned on. First, whether to continue with the glide path down for the Statutory Liquidity Ratio to reduce the degree of sequestration and facilitate transmission. This looks unlikely at this points, given concerns on the rise in interest rates, which an SLR cut guidance might aggravate. The second is a move to introduce a market benchmark linked loan pricing or modify the existing marginal cost of funds based lending rate or MCLR. This is a difficult exercise, given the lack of appropriate benchmarks, and the structure of liabilities of Indian banks (particularly their so-called Current and Savings Accounts, CASA). The focus will be on facilitating credit flows to small and medium enterprises and other growth sectors and making Indian markets more resilient to the likely rise in volatility over the next year.

Saugata Bhattacharya is senior vice president - business and economic research at Axis Bank. Views are personal.

The views expressed here are those of the author’s and do not necessarily represent the views of BloombergQuint or its editorial team.