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RBI rate review: Growth concerns likely to outweigh rise in inflation

The MPC had modestly revised its CPI inflation forecast for Q2 of FY2020 to 3.4 per cent.

ET CONTRIBUTORS|
Dec 02, 2019, 02.25 PM IST
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RBI
The MPC had provided forward guidance, by indicating that it would retain the ‘accommodative’ stance for as long as necessary to revive growth.
By Aditi Nayar

RBI’s Monetary Policy Committee (MPC) reduced the repo rate by 25 bps to 5.15 per cent in its October 2019 policy review, bringing the total magnitude of easing in 2019 to 135 basis points.

The widening of the negative output gap coupled with relatively stable retail inflation prints in the previous few months, as well as prevailing expectation of rangebound CPI inflation over the next three quarters, supported the MPC decision.

Importantly, the MPC had provided forward guidance, by indicating that it would retain the ‘accommodative’ stance for as long as necessary to revive growth.

The committee had modestly revised its CPI inflation forecast for Q2 of FY2020 to 3.4 per cent from 3.1 per cent in August, 2019. This was in line with the prevailing hardening in vegetable prices, which at that time was expected to reverse.

This apart, the MPC had remarked that the outlook for food inflation had improved since the August 2019 policy review. Partly benefitting from this, the inflation estimates for second half of FY2020 and Q1 of FY2021 had been retained at 3.5-3.7 per cent and 3.6 per cent, respectively, with the risks evenly balanced.

However, the subsequent release of inflation prints has revealed an unpleasant trend, in contrast to the MPC’s expectations. The CPI inflation has surged from 3.3 per cent in August 2019 to 4.6 per cent in October 2019, led by food and beverages, on account of a spike in vegetable prices as well as higher inflation in various other food items.

With heavy rainfall continuing in October 2019, which resulted in damage to standing crops, a disruption to vegetable output and supply, and a delay in rabi sowing, we expect CPI inflation for food and beverages to rise further in November, 2019. Subsequently, it would ease gradually, remaining higher than 5.0 per cent in the remainder of FY2020. Moreover, we expect the core-CPI inflation to inch up modestly from the level recorded in October 2019, as the favourable base effect wanes, but not breach the 4 per cent mark in the remainder in this financial year. We now anticipate that CPI inflation will exceed 4 per cent, i.e. the mid-point of the MPC’s medium-term target of 4+/-2 per cent, in the next few quarters.

Following the unexpected flareup in food inflation, it appears inevitable that the MPC’s forecasts for the headline CPI inflation would be revised upwards in the December 2019 review.

In October 2019, the committee had sharply reduced its projection for economic growth for FY2020 to 6.1 per cent (with risks evenly balanced) from the prevailing 6.9 per cent (with risks to the downside). Moreover, it had corrected its forecast for GDP growth for Q1 FY2021 to 7.2 per cent from 7.4 per cent.

With a further deceleration in the economic growth momentum, GDP growth stood at a modest 4.8 per cent in H1 of FY2020.

Subsequently, the available lead indicators present a mixed picture for October 2019, with a deeper contraction in core sector output amid a pickup in other sectors such as the consumption of petrol and ATF.

In light of the recent data, the MPC’s growth forecast of 6.1 per cent for FY2020 appears increasingly optimistic. We expect the committee to pare its forecast for the GDP growth for FY2020 in the December, 2019 review.

The sharp uptick in the headline CPI inflation in October 2019 was in contrast with a dip in the core-CPI inflation that month, as well as moderation in GDP growth in Q2 of FY2020, complicating the next policy decision. Based on the guidance provided by the MPC regarding the accommodative stance, we anticipate the committee to reduce the repo rate by 25 bps in the December 2019 policy review, looking through the vegetable price-led uptick in the CPI inflation.

However, this decision may not be unanimous. Moreover, the outlook for subsequent rate cuts would be dependent on incoming data.

With the CPI inflation expected to exceed 4 per cent over next several months, we look forward to the MPC’s views on whether they are willing to tolerate the headline CPI inflation remaining above 4 per cent, but below 6 per cent for several months in a row, if this uptick is driven by food items (as appears likely at present), while maintaining an accommodative stance and cutting rates further, if growth doesn’t revive.

Nevertheless, we maintain our view that the efficacy of incremental rate cuts in enabling a quick turnaround in economic growth appears modest in the current context, given continuing constraints such as moderate capacity utilisation levels, the cost of land acquisition, relatively high debt levels of some corporate groups and reluctance of the banks to lend for project finance.

(Aditi Nayar is Principal Economist at ICRA. Views are her own)
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)

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