The anticipated hit to India’s growth from global headwinds is unlikely to be offset by domestic demand, hence the need to stimulate domestic demand via monetary action.
Political theatrics in the run-up to the upcoming general election are expectedly in full swing, with economic claims and counter-claims, and lollipops to voters carving out a noisy looped life of their own. Against this backdrop, there appears to be incrementally less intensive focus on this week’s announcement by the monetary policy meeting (MPC)—compared with its recent meetings. The dollar-rupee swap announced by RBI to provide durable liquidity is a major shift that also diminishes the scope for additional significant action on liquidity. A 25 bps cut in the repo rate, to 6%, appears to be in the bag. However, there is a strong case that the combination of a benign inflation outlook, the anticipated downward revision to GDP growth, softening global demand, and the recently revised interest rate guidance by the FOMC strengthens the case for an outsized 50bps cut, to 5.75%.
At the last meeting in February, MPC members unanimously revised the policy stance to “neutral” from “calibrated tightening”, but were split 4-2 in cutting the repo rate 25 bps to 6.25%. The lower-than-target inflation wasn’t the only reason behind the outcomes of the meeting; the members also expressed concerns about India’s growth outlook. Given dark clouds over global growth dynamics, these concerns warrant concrete policy steps to cushion against the likely adverse impact on India’s growth. The MPC outlined in February that headline inflation would remain slightly below or at the official target of 4% over the next one year. This assessment will probably be reaffirmed this week, creating room for stronger rate action to aid growth. Indeed, the MPC should capitalise on the opportunity to frontload the available room for easing. It should cut the policy repo rate 50 bps now rather than, say, announce a cut of 25 bps now and another 25 bps reduction at the next meeting in two months.
CPI inflation jumped to a four-month high of 2.6% in February due to costlier food items. Howwever, headline inflation remains well below the MPC’s medium-term inflation target of 4%. Food inflation is poised to move into positive territory, though the pace and magnitude of the adjustment carry considerable uncertainty. Core inflation eased slightly, but still remains elevated. Economic growth slowed to a five-quarter low of 6.6% in October-December 2018. The government’s growth estimate for FY19 has been revised downwards, to a five-year low of 7% (earlier forecast: 7.2%). In the February statement, the MPC’s guidance was for 7.4% in FY19, and it pegged growth in FY20 at the same level.
Domestic activity indicators offer a mixed-to-deteriorating picture with a convincing upturn in private investment still elusive and the support hitherto from consumption receding. Rural demand dynamics continue to be subdued. The upbeat signals from India’s Purchasing Managers Index should be read with caution as economic growth has decelerated in recent quarters despite the survey’s signals of expansion in activity; frankly, the survey results have never been a reliable leading indicator of reported GDP growth or of manufacturing activity.
The bottomline is that the MPC will likely have to revise downwards its growth outlook. The anticipated hit to India’s growth from global headwinds is unlikely to be offset by domestic demand, hence the need to stimulate domestic demand via monetary action. Would the anticipated repo rate cut be complemented with a change in stance to “easing” (or “calibrated easing”)? I don’t think so as it is still premature for the MPC to be convinced that the inflation trajectory offers scope for several rate cuts. It is a mistake to conclude from the current benign inflation dynamics, significantly affected by unsustainably low food inflation (which has started to reverse) and weakening economic activity that India has put the inflation genie back in the bottle, and that the 4%-target will be met consistently over the medium-term.
Still, the inflation trajectory over the next one year offers sufficient flexibility for limited easing to support growth. A neutral monetary stance isn’t inconsistent with a 50 bps cut in the repo rate. The magnitude of the rate cut is decided by the assessment of the need, the urgency, and the available room to ease. It is admittedly a more aggressive step, but one that will obviate the need for a pedestrian pace of adjustment when the likely inflation path won’t alter meaningfully by the time of the next MPC meeting in June. The change in the monetary stance is dictated by the MPC’s confidence about the risks to the outlook and whether they allow for unidirectional and multiple rate adjustments. Frankly, it is hard to expect the MPC to be ready to signal an easing rate cycle when it is facing uncertain normalisation in food inflation and still-high core inflation. Also, it will wait for some colour on this year’s monsoon before reviewing the stance.
Unlike February’s rate decision, a 25 bps cut this week is likely to be unanimous. However, a 50 bps move, if announced, will likely be a split vote simply because the two members who voted for unchanged rates in February won’t be able to offer sufficient justification for favouring a bigger rate cut this time. Liquidity management isn’t in the MPC’s domain, but RBI has been egregiously slow to respond to the challenge of liquidity tightness. It is finally addressing it more effectively via the new dollar-rupee swap. This, along with the seasonal bias towards favourable liquidity at the beginning of the new fiscal year as government spending picks up—and the dissipating impact of the election-related surge in currency in circulation—should improve the availability of liquidity and hence monetary transmission. While surplus liquidity is inconsistent with a neutral monetary stance, it is unclear why RBI hasn’t already reassured investors about ensuring neutral liquidity, in sync with its change in the monetary stance in February. Perhaps, it can learn from its own corrective actions on liquidity management in 2016. After a delay in shifting the gears of monetary policy, the MPC should redeem itself by stepping up with a more aggressive 50 bps cut in the repo rate. The inflation-growth outlook offers a tactical opportunity to do so.
Postscript: Governor Shaktikanta Das deserves full credit for reinstating the uploading of the transcript of the post-policy call with researchers on the RBI website. Das’s predecessor had buried it without any explanation, after several years of its useful existence. Unfortunately, for the overwhelming majority of researchers—many are otherwise quick to offer wisdom on transparency and accountability—this was not important enough to prompt them to speak up. Many thanks, Governor Das, for correcting an unnecessary mistake.