The February Monetary Policy Committee (MPC) meeting has assumed greater significance as the markets would be carefully observing whether the first MPC meeting of the new RBI governor brings in any nuanced adjustment to the now well-established ‘flexible’ inflation targeting framework. To make matters more interesting, there are at least four areas where the MPC will have to deal with conflicting signals and uncertainties. Let us look at each of these issues to better assess the probable policy response function of the MPC.

The first issue is the perplexingly high core inflation coexisting with unusually low food inflation. While several tentative theories can be put forward to explain the slump in food prices, the sudden surge in education and health components of the core CPI remains rather puzzling.

In our view, there is a clear case for ‘looking-through’ the health and education CPI divergence from rest of core CPI till the source – supply side or demand side – of these price pressures is better understood. However, that does not necessarily mean that the MPC can be complacent about the inflation outlook because core inflation is still close to 5% even after removing the outliers of health/education components. On top of it, extrapolating the benign food inflation momentum akin to an adaptive expectations modelling of food prices could be erroneous especially when the base turns adverse in the latter part of the year.

Mixed growth signals, both domestic and global, could be the second challenge before the MPC. They have been quite sanguine on growth till the December policy and hence it will be an important departure when they analyse the recent consumption softness. If it is more due to unavailability of finance, then measures beyond rate cuts might have to be deployed. The political uncertainty around the elections could also cloud the assessment about the growth outlook. The current pace of growth is unlikely to fuel a sharp rise in core inflation but, at the same time, may not be soft enough to warrant simultaneous monetary and fiscal policy support.

In fact, uncertainties around the fiscal impulse would be the third factor affecting the MPC response. Although the slippage from the FRBM-mandated fiscal glide path is modest, large injection of cash in the rural economy, steadily increasing off-balance sheet spending and doubts about some of the fiscal projections could make the MPC wary about the inflation impact down the line. Let us not forget that a more lasting solution to the rural problems would be achieved only when the food price deflation reverses and the MPC will have to judge whether the fiscal package by infusing cash into the rural economy could trigger an early reversal in food price deflation or not.

The fourth challenge consists of an array of topics on which the MPC under the guidance of the new governor could make nuanced adjustments from their earlier narrative while keeping the broad institutional mechanism intact. Acknowledging the difficulty of perfecting the medium term forecast (9-12 months) of a food-heavy headline CPI, the MPC can increase the relative emphasis on near term (6 month) forecasts. This could possibly reduce the divergence between ex-ante and ex-post real interest rates and slightly increase the relative weight of the growth objective, though the rate trajectory could be more volatile.

It is difficult to justify retaining the ‘calibrated tightening’ stance when headline CPI has persistently undershot RBI targets and is expected to stay below 4% till H1 FY20. However, uncertainty around the interplay of fiscal stimulus and inflation could make the MPC defer the rate cut in the February policy. The timing of policy easing between February and April is less important. Markets would be surprised if the MPC leaves any hint about more than a ‘shallow’ rate easing cycle—we expect 25-50bps this year.

Samiran Chakraborty is the chief economist at Citi India.