Mumbai: Weak economic growth and higher inflation will put the Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) in a difficult spot when it meets in early December to deliberate on further accommodation.
Many expect a split among the six MPC members over a rate cut decision, given the economic meltdown. The decision would depend on whether the MPC members believe that the recent increase in food inflation is transient. The MPC is scheduled to meet during December 3-5 and announce the final outcome for the fifth bi-monthly monetary policy on December 5, a week after the government releases the second quarter GDP numbers on November 29.
Inflation as measured by the Consumer Price Inflation Index (CPI), came in at a 16-month high at 4.62 per cent for October, breaching the RBI’s medium-term target of 4 per cent due to a spike in food prices, especially vegetables and is likely to remain outside its comfort. Core inflation, however, was benign at 3.5 per cent, continuing to highlight weak demand impulse.
On the other hand, the dismal Index of Industrial Production (IIP) performance for the second consecutive month in September pointed to a deep slump in economic activity. The weakness was broad-based across a mix of consumption and investment indicators. With tight domestic credit conditions persisting amid weak global demand, economists expect India’s recovery to be delayed and the pickup to remain below potential. Global rating agencies and domestic economists have lowered their GDP growth projections steeply. For instance, Moody's Investors Service cut India's economic growth forecast for current year to 5.6 per cent from 5.8 per cent estimated earlier, saying the GDP slowdown is lasting longer than previously expected. Similarly, Nomura cut GDP projections to 4.9 per cent YoY from 5.7 per cent in 2019 and to 6 per cent from 6.9 per cent in 2020.
September IIP growth was at (-)4.3 per cent. led by weak momentum and adverse base effects.
Consequently, IIP growth for 2QFY20 was poor at (-)0.4 per cent as against 3 per cent in 1QFY20.
After the fourth bi-monthly monetary policy on October 4, the RBI has been emphatically firing on all three cylinders of rates, liquidity, and guidance. The MPC has cut rates by 135 bps backed by liquidity and guidance as well. Economists feel that a pause at this juncture could reverse part of the transmission that has occurred through the bond markets, making it an uphill task to convince banks and markets to pass on previous rate cuts.
“With CPI inflation likely to overshoot the MPC’s target of 4 per cent by around 75-125 bps over the next few months, we believe that the policy decision will be split among the MPC members given that inflation is trending above 5 per cent and growth is likely to be below 5 per cent in 2QFY20…The MPC members’ perception about ‘flexible inflation targets’ will be tested in the December policy,” Upasna Bhardwaj, Chief Econo-mist at Kotak.
“We expect the weak 2QFY20 GDP report, which will be released before the early-December rate review, to prod the MPC to ease rates by 25 basis points next month...Our forecasts include another 25bps reduction in 1Q20,” said Radhika Rao, Economist at DBS Bank.
Madhavi Arora, Economist at Edelweiss Securities said, “For the RBI, it presents a tough policy dilemma of overshooting inflation, undershooting growth and fragile fiscal state. However, we think the current underlying growth-inflation mix continues to be favourable for counter-cyclical monetary stance.”
