Another lengthy pause by RBI
The run-up to the monetary policy is different this time as there is less pressure being put on the monetary policy committee (MPC) to lower interest rates. This is on account of two reasons. First, the trend in inflation has been northwards which has in fact, led to conjectures of possible increase in interest rates in the course of the year. Second, the focus has been a lot on the Union Budget which has deflected attention to an extent. More importantly, the numbers in the budget do not suggest that either liquidity will ease or that rates will come down. The market reacted negatively with yields moving up.
The monetary policy has been reduced to a decision being taken on interest rates by the MPC with limited doses of structural issues being addressed as critical subjects like NPAs or bank capitalization are outside the system. Further, the call on rates is with the MPC which has been given a target inflation rate with a band to examine. In the past, CPI inflation within the band limits has elicited differential responses. Therefore, it is a decision taken on not just the CPI inflation number but expectations on the future trajectory.
CPI inflation has been increasing and peaked at 5.2% in December. There is reason to believe that the number will be higher for January too. Therefore, at this present juncture, lower inflation may be ruled out. Besides, the internals of inflation are pointing towards hardening of prices especially those relating to fuel. The house rent impact too would continue to linger for another 4-5 months and hence statistically keep the inflation number elevated. Further, while the impact of higher MSP on inflation should not be overstated, it would, at the margin, lend an upward bias to the CPI index—though this would become relevant only in FY19 when these prices are announced.
The budgetary content would probably reinforce the argument that a pause on interest rate action is required. First, the fiscal slippage witnessed in FY18 was significant and came in even lower than it would have been had capex not been pruned by around Rs30,000 crore. The target for the fiscal deficit for FY19 has been kept lower at 3.3% and involves a similar level of gross borrowing target for the government. Any slippage on revenue (especially tax or disinvestment) could result in higher borrowing. Second, the government has fixed an interest rate range of 7.35-7.68% for the bank recap bonds which though fixed based on a formula indicates that the government does not really expect interest rates to come down in this year. Third, the budget has assumed a neutral inflation rate of 4-4.5% based on the nominal growth of 11.5% growth in nominal GDP which can be split between 7-7.5% in real GDP and 4-4.5% in inflation. This number looks a bit aggressive considering that inflation has been in this range with relatively stable oil prices. As it is not expected that crude oil prices will cool down in the next 6 months, this number would tend to be higher. In fact, this is a heroic assumption made as the fuel subsidy has been fixed at the same level of last year, while excise collections on diesel/petrol have increased, which indicate that there would not be any extra support from the budget on fuel prices.
At the ideological level, there could be discussion on how to look at CPI inflation as the Economic Survey has provided an alternative view. While global central banks and the RBI are looking at monthly changes to take a call, the Survey has mooted the idea of using an average concept which was 3.3% till December which was below the 4% mark and should provoke a different response from the central bank. Conceptually, there can be no denying that this is an idea worth debating by the committee.
The RBI had earlier put a forecast of 6.7% for GVA growth for FY18, which is unlikely to change this time with a call more likely to be taken in April. The RBI could also provide some guidance on future inflation, which was put in a range of 4.3-4.7% for the second half of FY18. This will be important as while GST rates have been lowered on several goods higher oil prices and consequent fuel prices would work in the other direction. RBI’s take would be interesting.
Madan Sabnavis is chief economist at CARE Ratings. Views are personal.
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