There has been a significant downward momentum in the India bond yields of late. This has been primarily driven by lower bond yields globally on expectations that the deflationary pressures unleashed from the Brexit event would lead to major global central banks adding more in the form of monetary easing and hence more liquidity flows for India. The further twists for the market were hopes of announcement of a “market-friendly” monetary policy committee (MPC) and also the new RBI governor.
While the announcement of the new governor and the MPC is awaited, the August monetary policy is still in the hands of Raghuram Rajan under whom the Indian economy has seen the transition to a Consumer Price Index-based rule for monetary policy decision making. Importantly, the targets for inflation that the RBI is likely to receive from the government in the near future are still not clear. For sake of argument in this piece, we would still think that the target for CPI inflation will be at 4+/-2% as has been set by the Urjit Patel committee. The near-term target is for 5% that the RBI would want to achieve by January/March 2017.
The headline CPI inflation numbers in the first quarter of the 2016-17 fiscal are not too comforting. In April-June quarter, FY17 headline CPI inflation averaged at 5.7%. This figure is higher than the RBI’s estimates of 5.3% for the quarter and also more than the entire 2015-16 fiscal’s average of 4.9%. Core inflation has also proved to be sticky due to supply side concerns and averaged at 4.6% in the first quarter compared to an average of 4.5% during last fiscal. In fact, the RBI governor has, in one of his recent speeches, explained that if inflation level is closer to the threshold, as it is now, it is more likely that inflation will breach the threshold and hamper sustainable growth. Keeping this context in mind, it is therefore hard to believe that there is any chance for the governor to reduce the repo rate immediately. Sorry, there will be no parting gift from the outgoing governor in his final monetary policy.
On the other hand, Dr. Rajan has also categorically pointed out in another instance that the monetary policy is not too tight and the slowdown in the credit growth is not due to the actions of the RBI with respect to interest rates but more to do with the stressed assets in the public sector banks. Thus, contrary to common arguments in the market, it would be erroneous to believe that just a cut in the policy rates will be able to kick-start the credit revival cycle and also overall growth momentum. Instead, he has pointed out that the clean-up of balance sheets of the public sector banks is much needed, a path that the RBI has already started to walk on and hopefully will take it to its logical conclusion. This clean-up cannot be achieved instantaneously and the economy will have to wait patiently for the desired results.
Meanwhile, the overall macroeconomic backdrop for India appears stable with limited risks seen from either the fiscal or the current account balances. Inflation has slid to more stable levels while there are some early signs of growth. The Constitutional Amendment Bill related to implementation of GST has been passed and it is expected that the remaining procedure will be a relatively smooth sailing. There are also expectations that headline inflation will decline with vegetable and pulses prices recently witnessing some dips. Good monsoons till now are likely to have a salutary effect on food prices. Furthermore, inflation upticks from consumption push out of the Seventh Pay Commission arrears could be limited as large areas of the economy are operating at sub-optimal capacity.
IDFC Bank’s projections indicate that Headline CPI inflation will decline from the current relatively elevated levels, and could find a floor at 5.1% by October/November 2016. This implies that the confidence with which RBI attained its first target of 6% by January 2016 could be missing so far as attaining the target of 5% by January 2017 is concerned unless prices of oil and other commodities were to fall further. In this scenario, RBI would most willingly be waiting out for some time for incremental data flows before taking any further action on rates. However, the overall tone of the August monetary policy is likely to remain “accommodative” and as supportive, RBI is likely to highlight its continued support to infuse “primary liquidity” via OMO when needed. While it remains difficult to assess the situation immediately, any chance of further rate easing by the RBI could open up much later in the calendar year though the incremental space of easing would remain extremely restrictive.
The author is chief economist, IDFC Bank