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finance | IST

RBI monetary policy: A dovish hike with a 5-1 vote

Mini

The committee must have studied closely the slow snaking of the core inflation from around 5 percent a year ago to 6.3 percent at last count.

The two-day meeting of the Reserve Bank of India's (RBI) Monetary Policy Committee (MPC) started on Tuesday and it must have completed most of its deliberations by now. The committee must have studied closely the slow snaking of the core inflation from around 5 percent a year ago to 6.3 percent at last count.
This is an uncomfortable data point for an MPC that has committed to the government that it will keep inflation at or around 4 percent.
The committee would have noted that the Goods and Services Tax (GST) collections are not getting beyond Rs 94,000 crore a month against the asking rate of Rs 1.1 lakh crore per month.
It would have noted with equal worry the potential expenses for food subsidy if the minimum support prices (MSP) declared are faithfully implemented. Expenditure overshoot at the centre and state level seem imminent and the only way fiscal slippages will be avoided by sharply cutting government capex.
Such capex cuts constrain capacity building and could have an impact on inflation.
However, the MPC will be at a loss as to how well the price support for crops will work and what the impact on consumer inflation. Professional forecasters see the impact anywhere between 25 to 70 basis points.
Which means, while there will be an upward bias to the 4.7 percent inflation forecast by the MPC for March 2019, it won’t be able to assess how much the impact will be.
The MPC will also have assessed that crude prices while being supported at $72 per barrel is also not able to breach $80. That said, it has worried enough and more about global growth, whose reasonably strong trajectory ensures more rate hikes from the US Fed, than less, unless tariff wars escalate.
In India too, the committee will have noted that the output gap is closing - that is extra capacities in most industries have run out leading to an imminent danger of price hikes by producers if demand picks up.
And it is tough to doubt demand going by the volume growth reported by many consumer companies. Dabur, for example, reported a sizzling volume growth of 21 percent for the April-June quarter against expectations of a 14 percent growth. Producer pricing power will certainly be a worry on the MPC members’ minds.
On the flip side, the committee must have noted the rather severe food disinflation in the country. Pictures of farmers destroying vegetables and dairymen demanding that several million liters of milk powder be gifted away to African countries so that prices remain viable in India won’t be lost on the committee.
The food disinflation is real and persistent and it also indicates deep pain in the farm sector with its attendant impact on dulling aggregate demand. Is a rate hike called for under the circumstances?
Again, the global scene is confusing, thanks to the trade war threats. The depreciation of the yuan in the past few weeks will have preyed on the members’ minds as it fears of more depreciation.
Is there, then a danger that the rupee will strengthen too much for our own good if there is a rate hike on Wednesday. The committee must have pondered over this.
The committee, of course, doesn’t need to only strike with rate hikes. It has two other weapons. It can change its stance from a promise to stay neutral on rates to a threat to “withdraw accommodation.”
That is the central bank speak for “I stand ready to hike rates and see a need for them in the future”.
The other weapon is liquidity, that is ensuring banks always remain short of requisite cash for the CRR (cash reserve ratio) needs and keep coming to the RBI for borrowing. For the past three years, the RBI policy has been to keep liquidity neutral, that is banks sometimes borrow from RBI and sometimes lend excess cash to it.
Strong Signal
An announcement that it is changing from neutral to tight liquidity can be a very strong signal to drive up rates. Such a strong signal to drive up rates may be unnecessary considering the last inflation reading at 5 percent was much lower than expectations of 5.3 percent and the next reading will be even lower.
Also, given the rapid clip at which people are withdrawing cash from banks, liquidity will tighten naturally and in fact, the RBI may have keep buying bonds (via open market purchases) all through September to March to infuse liquidity.
It seems unlikely the MPC will toy with the idea of tightening liquidity. A question the MPC will have pondered is: While higher CPI is a worry given higher MSP and core inflation, are these inflation fears dire enough for the RBI to resort to back-to-back hikes in two consecutive policies?
It is possible that some members want the MPC to hike but keeping the stance neutral to indicate that there is no case for a series of hikes. Alternatively, some members may not want a hike until they are sure of the impact of the MSP.
The members, however, may want to warn that a hike is more likely soon. In central bank speak, the former may want a dovish hike, while the latter may vote for a hawkish pause.
In sharp contrast to the unanimous vote last time, this time the MPC may be split. I think a 5-1 in favour of a dovish hike is possible