Deep Dive. (Photographer: Nadja Brandt/Bloomberg)

MPC’s Dilemma: How Deep Is The Slowdown?


How deep is our slowdown?
I really mean to learn,
‘Cause we’re living in a world of conflicting indicators,
Leaving us confused when they all should let us be...

If India’s Monetary Policy Committee wanted a theme song for their next meeting, maybe they could spin a growth-inflation version of the 1977 Bee Gees classic ‘How Deep Is Your Love’. For ‘How Deep Is Our Growth Slowdown’ is really the only question that the MPC needs to answer at its April meeting next week.

To begin with, a 25 basis point cut in the repo rate to 6 percent appears highly likely. But that rate cut can be justified purely on the basis of the inflation outlook. In its February policy, the MPC had said it sees inflation staying below 4 percent all the way into the third quarter of FY20. With no sudden or sharp reversals in retail inflation evident yet, that inflation projection leaves room for lower rates.

While the RBI appears to have abandoned the broad benchmarks for real rates (1.5-2 percent) adopted during Raghuram Rajan’s years, a real rate of above 2 percent, at a time when growth is hardly booming, leaves scope for at least one more rate cut.

The question is whether the MPC needs to go beyond that second rate cut. Either by cutting rates by a steeper-than-expected 50 basis points or by signalling that more rate cuts are in the offing over subsequent policy meetings.

This is where the MPC will need to make an assessment of growth because inflation, barring any further shocks, will start to normalise simply on base effect if nothing else. As inflation normalises, rate cuts will have to be explained via an expectation of weak or weakening growth, which will then seep into demand-driven inflation.

So it’s the MPC’s judgement on growth that will now matter to assess the future trajectory of policy.

What is growth looking like? Much easier asked than answered. The views range from depressive to delusional. The best we can do is look at available data and try to segregate that data into the good and the bad.

Growth Data: The Good

While the sentiment around growth has soured dramatically, there are still some reasonably credible data points which are holding up.

The survey based Purchasing Managers Index, both for manufacturing and services, is one such data point. The manufacturing PMI hit a 14-month high of 53.8 in February. The indicator has held up reasonably well and has been consistently strong since the start of 2018. The services PMI has also been steady and printed a reading of 52.6 in February, marginally lower than the previous reading of 53.

Bank credit growth is the other indicator that has held up well. At 14 percent, growth in bank credit is reasonably strong. In fact, in recent months, you have finally started to see a pick-up in industrial credit, along with already strong retail credit.

Other real sector indicators that remain strong include demand for steel and cement, which fits in well with the theme of a revival in investment, albeit one driven by government projects rather than private projects.

Core inflation, which is an indicator of demand, also remains elevated at between 5.5-6 percent, suggesting there is no collapse in demand.

Pranjul Bhandari, chief India economist at HSBC, said in a note last week that half of the indicators the bank tracks are slowing but the rest are holding up. “Across the 40-odd real indicators we track, we find that 50 percent of them are slowing sequentially, though the remaining are improving,” Bhandari wrote. HSBC expects growth to rebound post elections back to a level of 7 percent in the second half of 2019.

Sajjid Chinoy, chief India economist at JPMorgan is also in the camp that is not unduly worried about growth. “The data is mixed. There are a number of indicators like the surveys, which have picked up quite smartly, we’re seeing cement and steel production stay strong, we’ve seen credit growth broaden...core industrial production numbers have been strong,” Chinoy told BloombergQuint in an interview on March 18. “I think the summary assessment is that while growth has slowed compared to two quarters ago, it appears to have stabilised. I don’t think we are in the midst of a sharp growth slowdown,” he added.

MPC’s Dilemma: How Deep Is The Slowdown?

Growth Data: The Bad

For every indicator looking stable, there is another looking weak. And for every economist saying that growth is not so bad, there is one saying that economic momentum is weakening and needs support.

Among the indicators that are worrisome are consumption trends.

Domestic passenger vehicle sales have been negative for four consecutive months and two wheeler sales have weakened in January and February. Commentary coming in from consumer firms also suggests that the January-March quarter has been weak.

Rural wage growth remains weak even though it has not weakened further in the last few months of 2018. Still, the effect of a long period of weak wage growth will impinge on rural demand.

Another indicator, which has shown recent weakness is imports. Non-oil, non-gold imports turned negative in January and February, perhaps suggesting weakness in domestic demand.

Sonal Varma, chief India economist at Nomura believes that indicators are pointing to a downturn in the business cycle. “We believe the GDP growth slowing to 6.6 percent in October-December 2018 (from 7 percent in July-September) is a harbinger of slower growth to come – descending to 6.0-6.5 percent in H1 2019,” she wrote in a note dated March 21.

Prachi Mishra, chief India economist at Goldman Sachs shares that view. Goldman’s ‘current activity indicator’ is pointing to a slowdown, Mishra said in a note dated March 27. “ The weakness in our CAI in February is driven by weaker tax revenues, lower air cargo, and slower exports and non-oil non-gold imports,” Mishra wrote.

To add to weak domestic indicators, expectations of weakening global growth have taken hold, prompting some economist to call for either a 50 basis point rate cut or a clear guidance of more rate cuts via a shift in stance.

“We believe the stage is ripe for a larger rate cut. If the rate cut is of 25 bps only, then RBI could indicate more cuts through a possible shift in stance/ policy statement,” said Soumya Kanti Ghosh, chief economist at State Bank of India.

MPC’s Dilemma: How Deep Is The Slowdown?

The ‘Complexifier’

The complexifier, to borrow a word popularised by Jeff Bezos, is the RBI’s own view on growth.

Remember that in the February policy, the MPC actually retained its growth forecast at 7.4 percent for the year, even though the government’s statistics department had already pegged down expectations to 7.2 percent. Since then, the government estimate for growth has been taken down further, to 7 percent. Until February, the MPC did not sound any alarm bells on growth although it acknowledged that the “output gap has opened up modestly.”

As such, the MPC first needs to accept that growth is a problem and explain what it sees as the causes behind the slowdown, before it actually takes steps to correct it.

Ira Dugal is Editor - Banking, Finance & Economy at BloombergQuint.