Cautious MPC surprises with a pause on rate cut

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Published: December 6, 2019 2:43:42 AM

Contrary to market expectations, the committee chose to keep the repo rate unchanged at 5.15% in today’s policy, given the prevailing uncertainty regarding growth-inflation dynamics, including the measures to support economic growth that may be unveiled in the Union Budget for FY21.

MPC, CPI inflation, inflationary risks, GDP growth, CPI inflation forecasts, GDP forecast for FY20The MPC has considerably pared its GDP growth projection for FY20 to 5.0% in the December 2019 policy review, from 6.1% with risks evenly balanced in October 2019.

With a spike in the CPI inflation in October 2019 and an unfavourable moderation in the GDP growth in Q2 FY20, the monetary policy committee (MPC) was faced with a complicated choice in the December 2019 policy review. We had anticipated that growth concerns would outweigh the inflationary risks, and prompt the MPC to reduce the repo rate for the sixth consecutive time, by 25 bps in today’s policy.

Contrary to market expectations, the committee chose to keep the repo rate unchanged at 5.15% in today’s policy, given the prevailing uncertainty regarding growth-inflation dynamics, including the measures to support economic growth that may be unveiled in the Union Budget for FY21.

Moreover, the delayed and incomplete transmission of the earlier policy rate reduction of 135 bps prompted the committee to pause in the December 2019 policy review. Additionally, the decision to pause was unexpectedly unanimous, with all six members voting in favour of the decision. However, the MPC reiterated that the stance will remain accommodative for as long as necessary to revive growth, and highlighted that there is monetary policy space for future action.

The third surprise is the extent of the reduction in the committee’s GDP forecast for FY20, given that it sees some incipient signs of a recovery. The MPC has considerably pared its GDP growth projection for FY20 to 5.0% in the December 2019 policy review, from 6.1% with risks evenly balanced in October 2019. Accordingly, it expects only a mild uptick in the GDP growth from 4.8% in H1FY20, to 4.9-5.5% in H2FY20, and further to 5.9-6.3% in H1FY21.
Unsurprisingly, the MPC has sharply revised its CPI inflation forecasts. It now expects the retail inflation in H2FY20 to print at 5.1-4.7% as opposed to its earlier projection of 3.5-3.7%, with risks broadly balanced.

Notably, this is considerably higher than the mid-point of its medium-term target of CPI inflation of 4%+/-2. Subsequently, it expects the headline retail inflation to ease to 4.0-3.8% in H1FY21, with risks broadly balanced.
In our view, the CPI inflation is likely to climb further in November-December 2019, which may result in another pause in the next policy meeting. The MPC may subsequently reduce the repo rate by another 25 bps, but only once there is clarity that the headline CPI inflation will sustain below 4%.

The writer is principal economist, Icra

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