RBI's emphasis on anchoring CPI inflation around 4% possibly hints at monetary policy committee's likely bias for a nuanced stance
The Reserve Bank of India (RBI) looks set to leave the repo rate unchanged next week. Since RBI’s last rate cut in the previous meeting in August, Consumer Price Index (CPI) inflation has scaled higher by about 200 basis points (bps), though not completely unexpectedly, to reach a five-month high. One basis point is one-hundredth of a percentage point. The current increase was driven mainly by food inflation, which often reverses quickly. However, given the markedly adverse base effects during the second half of the fiscal year, CPI prints will likely continue their gradual uptrend, potentially entering into a 5% handle in early 2018. Monsoon outcome in 2017 was also a mixed bag. Cumulative headline rainfall during the 2017 monsoon season, at around 95% of the long-period average, is only marginally below the “normal" range of 96-104%. However, spatial and temporal distribution of rains has been materially less favourable.
Gross domestic product (GDP) growth print, at 5.7% year-on-year for the April-June quarter, surprised on the downside. However, concerns of a structural downtrend are exaggerated, in my view. The drop in GDP growth since Q4 2016 was driven by multiple and sharp one-off disruptions such as demonetisation and GST (goods and services tax) implementation, and was not due to fundamental dents in key growth drivers.
Admittedly, the rupee has strengthened by about 5% this year and fiscal support remains limited, but lower interest rates have, to an extent, been a counter-balancing factor. While weakness in economic activities in the recent months is clear, one needs to avoid over-interpreting the latest set of GDP data as well for a variety of reasons.
First, private final consumption expenditure (PFCE) surged by over 11% in Q4 2016, versus a trend growth rate of 7-8%, likely reflecting conversion of wealth into consumption post-demonetisation. The current soft patch for consumption growth might simply reflect a spell of averaging following the Q4 2016 spike in PFCE, the largest driver of India’s GDP. Second, growth in tradables sector in Q2 2017 fell sharply while that in non-tradables rose. This might be related to the GST roll-out, which reduced taxes for manufacturing but raised the same for the services sector Q3 2017 onward. We believe the reverse could happen in H2 2017, with a potential stronger increase in the tradables sector versus softening in services. Third, revisions in GDP statistics are typically large and upward; the three latest revisions (Q1-Q3 2016) in official data averaged +76bps. Thus, comparing initial GDP estimates (Q4 2016 onwards) with revised/final estimates might be significantly misleading.
Overall, while GDP growth will likely stay below 7% during 2017-18, a gradual “normalization" in economic activity after the current near-term disruption remains the baseline expectation. Indications from high-frequency data remain mixed and suggest avoiding excessive pessimism at this juncture.
The current macroeconomic backdrop in India is characterized by a rather unusual combination of slow growth and by and large soft inflation, potentially leaving room for policy bias, over time, towards a mix of easier monetary policy, stronger fiscal policy support, and a weaker currency. RBI has cut the repo rate by 200bps since 2015. Banking system liquidity has also been eased by and large during the past 18 months. Admittedly, the monetary policy committee (MPC) has largely maintained a cautious stance in the past year.
RBI’s emphasis on anchoring CPI inflation around 4%—unless we witness a de-emphasis of the same in the coming months—possibly hints at MPC’s likely bias for a nuanced stance. Nevertheless, MPC debate is set to stay anchored around “hold versus cut". While status quo on the repo rate over the coming months is my baseline expectation, one needs to recognize that monetary policy will likely remain data dependent with risks of further easing. Policymakers could also develop a bias against renewed rupee strength.
Finally, the backdrop of slow growth and subdued inflation, if persists, could provide room to revisit India’s fiscal policy stance over time. The weak flow of tax and non-tax revenues during 2017-18 (For example, a smaller RBI surplus transfer, weak disinvestment proceeds, uncertainty around GST revenue) squeezes the space for material additional government spending immediately. However, one feels that the government might eventually turn more open towards “adopting" a somewhat relaxed fiscal deficit target in 2018-19.
Siddhartha Sanyal is the chief economist - India at Barclays Bank PLC. Views expressed herein are personal.
This is the third in a series or columns ahead of RBI’s bi-monthly monetary policy meeting on 3 and 4 October.