Opinion | The monetary policy strongly emphasized the need to support growth

The MPC notably referred to a growing slack in the economy and the need to support private consumption and investment.
The MPC notably referred to a growing slack in the economy and the need to support private consumption and investment.

The inflation trajectory and neutral stance open up room for further accommodation

The first monetary policy of 2019 was also the first by the new governor at the helm of the Reserve Bank of India (RBI). The policy came against the backdrop of a supportive and benign global rate environment, as growing concerns about a broad-based global growth slowdown had piloted all central banks, including the US Federal Reserve, to suddenly shift towards a dovish leaning.

This policy also came on the heels of what many analysts have dubbed an “expansionary budget" and a monetary policy committee (MPC) stance that was in calibrated tightening mode. It was, hence, imperative that the governor walked the tight rope balancing two different forces. In this context, in addition to the MPC statement and the actual rate action, the focus was also on Shaktikanta Das’s post-policy speech, body language and how he justified the MPC action. The market was pleasantly surprised and relieved on all counts.

Aside from the unexpected rate cut, the two big takeaways for us were the steep downward revision in the expected inflation trajectory and the subtle reference to the need to support growth even as inflation impulses remain well-controlled.

Inflation forecasts have been revised lower by around 60 basis points (bps) for the first half of next fiscal year and the Q3 FY20 inflation average has been estimated at 3.9% year-on-year. This is a good 100 bps lower than our own estimates. While the RBI has adjudged the short-term outlook for food inflation as quite benign, other factors such as oil prices and a steep fall in household inflation expectations are also supportive. The concern on the sticky core inflation was also addressed by the RBI as a “one-off" effect resulting from a recent pick up in health and inflation. As a result of these revised estimates, the consumer price index (CPI) trajectory now remains comfortably below 4% for calendar 2019.

The other key takeaway is more subtle, but has pervaded across in the statement and in the post-policy discussions. The need to support growth was emphasized strongly as inflation objectives were in control. The MPC notably referred to a growing slack in the economy and the need to support private consumption and investment. Compared with earlier forecasts, GDP growth has also been revised lower to 7.4% y-o-y for FY20, in line with our own forecast.

The inflation trajectory and the neutral stance open up room for further accommodation within what we call a shallow rate cycle in the absence of any adverse developments. It is more the expectation than the action itself that will guide the bond market for the next two months, as other factors are mostly benign. However, the magnitude of the government borrowing programme brings about an upward pressure on rates, thus presenting an interesting dichotomy to this favourable rate environment. The markets have immediately reacted to this eventuality with a steepening of the curve, and we expect this phenomenon to continue in the near future. The swap market, that is a pure play on the rate environment, presents a better opportunity in the short end to play this shallow rate cycle. We expect the 10-year yield to trade in a range of 7.30-7.65% and 7.15-7.50% for the old and new benchmarks, respectively.

As regards capital flows, India has underperformed compared with other emerging markets in the last few weeks, even while peers have received substantial flows amid the turnaround by the Fed. Now that two significant events—the interim budget and the new governor’s first policy—are out of the way, we could see some flows returning on improved global risk sentiment.

Even seasonally, this is a favourable quarter for India’s balance of payments. In this regard, if the currency stabilizes in a range, then other regulatory steps taken, such as withdrawal of concentration limits for foreign portfolio investors (FPIs) in corporate bonds, could encourage flows.

However, the need for the RBI to recoup reserves and the acknowledgement of the economy’s need to retain competitiveness, will set a floor for the rupee.

We will hence retain a mildly depreciating bias for the rupee, which could still be less than the long-term inflation differential. The general elections are due in May this year and significant volatility would be witnessed around the time. For now, we expect the rupee to trade in a range of approximately 70-72.50.

B. Prasanna is head, global markets group, ICICI Bank

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