Status quo expected, but take on inflation, liquidity and yields key
The last monetary policy meeting of the year will be interesting to watch out for—not for the rate action, which I think will be absent as the Reserve Bank of India (RBI) will likely stand pat—but for the central bank’s take on the evolving trajectory of inflation, cues on liquidity management and yield signals.
As for growth, the largest downgrade of its own projections since fiscal 2000-01 notwithstanding, RBI has made it abundantly clear it believes the growth slowdown to be transitory and will pick up as one-off effects wane over the next few quarters. Note that RBI in its October policy raised its inflation forecast for the second half of fiscal 2018 to 4.2-4.6% from an earlier 4-4.5% while reducing gross value added estimate to 6.7% from 7.3% earlier. In fact, the October policy stance signalled many pre-conditions for future rate cuts such as inflation surprising on the downside, fiscal slippage within tolerable limits in view of the Seventh Pay Commission wage hike by states and farm loan waivers and entrenchment of a slowdown—which doesn’t seem to be the case as GDP numbers for September quarter suggest.
Quite a few things have happened since the last policy which may keep RBI on pause. First, the uncertainty around the fiscal targets has risen significantly. The finance minister recently hinted at a recalibration of the fiscal consolidation road map vowing to continue with the glide path: “No pause (on fiscal consolidation) but challenges arising from structural reforms... could change the glide path.”
The October revenue collections under the Goods and Services Tax (GST) came in at Rs83,300 crore lower than the monthly average collection of Rs92,300 crore since its implementation. The volatility in monthly GST numbers increases uncertainty around tax compliance and amplifies the fiscal worries given that the fiscal deficit, as of October, has already climbed to 96% of budget estimate for this fiscal.
Importantly, lower GDP growth will also weigh on overall tax revenues—especially, direct taxes. Also, non-tax revenues are set to come under pressure as collections from dividends from RBI, and spectrum auctions are expected to be short by about Rs70,000 crore or 0.4% of GDP.
Not surprisingly, Michael Patra, a member of the monetary policy committee (MPC), quoting governor Urjit Patel, recently re-emphasised that the panel will seek to achieve the primary objective of inflation while also trying to support growth going forward.
Second, there has been a broad-based rise in CPI inflation excluding food and fuel. International crude prices, which had started rising from early July, have firmed up further with possible risks to the upside. A sharp uptick was also seen in housing inflation and the October CPI print witnessed a higher than expected momentum of 1.2% month-on-month. This seems to indicate that there is also some state HRA (housing rent allowance)increase and its pass through to the print over and above the central HRA.
Moreover, in the September quarter, input cost as a percentage of sales has risen by nearly 150 basis points (bps) quarter-on-quarter for BSE 500 companies (ex- financial companies), but earnings before interest, taxes, depreciation and amortization margins have moved up a tad. This suggests that apart from cost control measures, firms have been able to pass on some of their input costs to consumers. One basis point is one-hundredth of a percentage point.
The MPC had also highlighted the implementation of the farm loan waiver by states and the introduction of pay commission awards by states as key sources of upside risks to inflation. State pay commission awards, it averred, were expected to add around 100 bps to the base line inflation over a period of 18-24 months.
Third, the interest rate transmission or rather the lack of it, was cited by RBI in its last policy. RBI stated that the base rate/ Marginal Cost of Lending Rate system (MCLR) regime was not in sync with global practices on pricing of bank loans and hinted that a switch-over to an external benchmark in a time-bound manner be made.
Hence, it may want to consider the recommendations of the study group to improve interest rate transmission. Note that over the last few years, there has been a shift from the prime lending rate to the base rate and then to the MCLR under which the weighted average cost of deposits was replaced by marginal cost of funds. But none of these have really yielded desired results.
Lastly, emerging concerns over the shape of the US yield curve may be one more additional factor that RBI may want to mull over.
This poses an additional concern over and above the factors cited by the MPC such as the escalation in global geopolitical uncertainty and heightened volatility in financial markets due to unwinding by US Fed and normalization by the ECB.
Sachchidanand Shukla is chief economist at Mahindra & Mahindra. The views expressed are personal.
This is the last in a series of articles in the run-up to the Reserve Bank of India’s bi-monthly monetary policy meeting on 6 December.