A waitress holds up a slice of cake. (Photographer: Geraldine Hope Ghelli/Bloomberg)

Monetary Policy: One More Slice On The Table


Global and local signs of deceleration mean the Monetary Policy Committee of the Reserve Bank of India would stay dovish and slice the repo rate by another 25 basis points during its April 4, 2019, review meeting.

More members are likely to support the cut than during the February review.

While there is talk about a 50-basis point rate cut in some quarters, there is a low probability of that happening because central banks typically move in small steps unless there is an emergency.

The recently executed dollar-rupee swap scheme of the RBI was an innovative effort that shored up liquidity. Focus on liquidity will continue to be sharp.

Over the past few months, particularly since the February review by the MPC, global and domestic macro conditions have become conducive to a growth-supportive monetary policy.

The softening stance of the U.S. Federal Reserve and the European Central Bank in response to weakening growth momentum has created conditions for a cut in interest rates in some emerging markets as well.

The Fed ‘dot plot’ now talks of no rate hike this year and only one in 2020.

Additionally, the yield curve inversion in the U.S. points to a rising probability of a recession over the next year, but there isn’t enough evidence yet to conclude so—despite the world’s largest economy decelerating. The ECB is also expected to stay paused.

The easing of financial conditions in advanced countries has led to a resumption of capital flows to emerging markets, including India, narrowing the interest rate differential with the U.S. and strengthening the rupee against the greenback.

On average, the rupee has strengthened to 71.5 per dollar in January-March compared with 72.1 in the quarter earlier, and is currently hovering around 69.

On the domestic front, while growth has slowed, headline inflation continues to remain benign. Consumer inflation in the 11 months of this fiscal has averaged 3.5 percent. GDP growth for fiscal 2019 has been revised down by the Central Statistical Office to 7.0 percent from 7.2 percent and lower than 7.4 percent projected by the RBI and CRISIL.

GDP growth in the second half of fiscal 2019 is expected to be slower at 6.5 percent.

In fiscal 2020, we expect GDP to print at 7.3 percent, or 10 basis points lower than the 7.4 percent average of the past five years.

Inflation Clawback Imminent

Consumer inflation should inch up in the next few months and would average 4.5 percent in fiscal 2020. Softer oil prices and strengthening currency reduce the ‘imported inflation’ pressure, but the food inflation is likely to move up from abnormally low levels. Over the past three years, food inflation has averaged a bare 2 percent – way below 7.2 percent in the past decade. Food inflation, which is currently negative and will average around 0.2 percent for fiscal 2019, is likely to ascend along with global food prices and will also be helped up by a low-base effect.

Monetary Policy: One More Slice On The Table

The normalisation of food inflation will be accelerated if monsoon this time turns out to be inadequate. While these are early days, global weather forecasters have been talking about the likelihood of an El Nino event this year, which can lead to subnormal rains after three ‘normal’ seasons.

A rise in food inflation, which has a 40 percent weight in the Consumer Price Index-based inflation, will immediately translate into a higher headline number because the largest component—core inflation—continues to be sticky above 5 percent.

Increasing economic slack has not materially lowered core inflation, which is averaging 4.5-5.5 percent for the past three years. Consumption focus of the fiscal policy will also create inflationary pressures, the extent of which will depend on how income support schemes get topped up.

Household inflation expectations have remained elevated although their link with overall inflation seems to have become weaker. In fact, after the introduction of inflation targeting in June 2016, the gap between 3-month-ahead household inflation and actual has widened 120 basis points to 500 basis points. A similar trend is noticeable in the 1-year-ahead expectations.

As for the expectation of analysts, which gets captured by the RBI’s Survey of Professional Forecasters, these are better aligned to the actual number now. The latest round of SPF projects consumer inflation reaching 4.2 percent by December 2019.

Neutral Stance To Be ‘De Facto’ Accommodative

The RBI’s stance should stay in neutral for now, and further rate cuts will be driven by the evolving situation both globally and locally.

The benchmark 10-year sovereign yield should hover around 7.5 percent by March 2020.

Yields will be weighed down by slower Fed rate hikes, low crude oil prices and interest rates, while weak fiscal arithmetic would exert counter-pressure.

In this milieu, the rupee would remain volatile and weaken to 72 per dollar on average by March 2020. The rupee will find support in benign crude oil prices and slower policy normalisation in the U.S., which means it’s fair to expect only a modest weakening next fiscal.

Given the macros, India’s current account deficit should reduce to 2.4 percent of GDP in fiscal 2020 from 2.6 percent in fiscal 2019. Lower oil prices would also mean slower import growth. Exports will also be tepid because of weakness in global trade.

Dharmakirti Joshi is Chief Economist at CRISIL.

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