RBI’s MPC highlights the googlies to watch out for!!

Any surprise from the central bank this time around? Not really as a rate cut was widely factored in by the markets immediately prior to the first bi-monthly monetary policy for the financial year. On the policy front, there were only two questions which could have got monetary policy enthusiast interested: One, whether the rate cut would be as bold as 50 bps or mild as 25 bps? Two, in cricketing analogy similar to the one used by Dr. Viral Acharya, whether the members would decide to get out of the crease and push for an” accommodative stance” indicating a more dovish policy going forward?

These question get validation from the vote count as the rate cut was not unanimous in favour of a rate cut (4-2) and also the vote count on the stance (5-1), reflective of the constructive disagreement among economists. However, what is prominent is the “Dravid-style” resilience shown by Dr Viral Acharya and Dr. Chetan Ghate in voting against the rate cut despite slashing the inflation forecasts by 30-40 bps and growth forecast for FY20 by 20 bps from the previous policy. Though the minutes are released after a gap of 15 days, it would be interesting to see the rationale behind the decision. Both certainly see an upside risk to inflation in the forthcoming months which back their decision.

A disagreement between the MPC members indicates that there is no level playing field for the members to take unanimous decision. Four interesting things in today’s policy which needs to be accentuated are:

• The hazy nature of crude oil price: The price of India’s most important imported commodity been as whimsical as women’s shopping brain driving inflation prints and forecasts hay-wire. The average y-o-y growth in crude oil prices (Brent) seen at around 45% in the first seven months in FY18 (Apr-Oct) led to the fuel component of CPI rising to 62 months high. A reversal in trend in Dec’18 and Jan’19 (contraction on an average of 13%) dragged the fuel component to a multi years low. Given this wide divergence, what is even more critical is the cloudy forecast of crude oil prices with either upside or downside risks. Crude oil prices at the moment are placed on the weighing scale with an uncertain demand condition amidst global economic slowdown on one side and supply cuts by OPEC on the other side, keeping the crude oil prices and consequently inflation prints at bay. 
• Food prices and monsoon: Food inflation has been in the negative territory since Oct’18 chiefly owing to supply glut in several food items at both domestic and international level. The reversal in vegetable prices in summer months and weaker momentum of deflation in other food groups could see the food prices in the positive territory. However, the weather forecast shows El Nino conditions strengthening which could affect the south west monsoon. A weak monsoon could adversely impact food production aggravating the prevailing rural distress and slowdown in agriculture gross value added (GVA). On the other hand, lower production could push up prices seeing an uptick in the food component of CPI. The committee having assumed a normal monsoon while forecasting inflation, keeps the inflation forecast almost 1% lower than the target for H1-FY20. But the interesting part will be the H2-FY20 food inflation, which on a low base and weak monsoon could exacerbate headline inflation.
•  Transmission and Liquidity: The one main reason which the central bank governor state in going against the 50 bps rate cut is a “soft transmission effect”. A 25 bps cut in the previous MPC incentivised banks to cut interest rate by 5-10 bps in the subsequent months. To bolster interest rate margins, the banks gains by lowering interest rates on deposits relative to loans in a falling interest rate regime. While interest rates transmission is faster on loans relative to deposits in an increasing interest rate regime. Falling interest rates does not attract the depositors eye. Lower attraction for deposits and higher credit disbursement could add to the concern of liquidity deficit in the banking system (stressed since Sept’ 18). RBI has however on a regular basis stringently monitored the liquidity position by infusing durable liquidity aggregating almost Rs. 3 lakh crs by open market operations (OMOs) and undertaking a long term rupee dollar swap of $ 5 Bn in FY19 infusing Rs. 35,000 crs in the banking system (RBI is also going to undertake rupee dollar swap of $5 Bn in April’19). A liquidity deficit in the banking system makes transmission of interest rate difficult and could see further liquidity infusion via OMOs to aid transmission.
• Global growth slowdown and change in stance by central banks of advanced economies; If slashing of growth projection for the Indian economy by multilateral agencies and central statistics office is a concern on the domestic front, the slowdown in growth in advanced economies and emerging economies has had second order effects on the Indian economy (especially via exports). The inverted yield curve in the US and negative yields in Germany are indicative of a possible recession going ahead (with some lag). This has led to a compete U-turn by major central banks moving from a hawkish stance in Dec’8 to voices of a possible dovish stance in the forthcoming policy announcements. With global growth flashing red signals and major central banks turning dovish, it would be interesting to see if RBI follows suit.

The RBI has cut its key policy rate for the second time in this calendar year. There could not have been a better time to cut policy rates with a need to stimulate growth and with inflation prints and forecast remaining below target amidst declining inflation expectations. However, monsoon, crude oil prices, liquidity and global growth concerns are the googlies which the central banks needs to carefully monitor to avoid being clean bowled!

Sushant Hede

4th April, 2019