The RBI has sprung a surprise by not altering the interest rates or lowering the cash reserve ratio (CRR) at a time when inflation appears to be moving up and liquidity tight. At the same time the perspective on growth for FY19 remains unchanged with 7.4% projection remaining intact. This calls for some discussion.
As inflation is the main target for the Monetary Policy Committee (MPC), the view is that the inflation projections for Q2 have changed downwards to 4% from 4.6% and to 3.9-4.5% for H2 from 4.8%. There are strong underlying assumptions where there could be a differing view.
First the increase in oil price looks likely given the uncertainty in the oil economy. Assuming that this may not have a sharp impact on inflation is bold because until November it is not clear how much higher the oil price may move. India is confronting two issues on oil – first the rising global crude price and second reliance on Iran where the US sanctions would be invoked in November. There we are vulnerable on two counts.
Second, the MSP impact will be sharp if it is effective. Docile food inflation would mean that the MSP has not worked and this is where the irony lies. The rabi MSPs have also been increased which will pressurise inflation in the coming months. Third, input costs increasing have been highlighted by the RBI which is reflected in the WPI inflation of manufactured products. Yet the stance is that inflation will come down. Probably the bet is that statistically this would come down over a higher base last year. Yet, the stance has been called ‘calibrated tightening’ indicating that rates could be raised in case inflation expectations are not met.
The fact that the CRR has remained unchanged means that the RBI will continue to be aggressive with the OMOs to provide liquidity to the system. This is something that the market can look forward to in the coming months. Liquidity has been tight due to a combination of reasons like dollar sales of RBI, greater demand from fund houses, higher holding of cash balances by the government etc. The implication of not lowering CRR can be that these phenomena were temporary in nature and that to the extent there is a deficit, OMOs would be used proactively.
How about GSec yields? They should move downwards and could probably go below 8%. Therefore, the unchanged stance is good for the bond market as an increase in rates would have meant that the 10-year yield would have moved to the 8.1-8.2% range.
However, one area which has not really been discussed in detail is the currency market, which is probably the burning issue in the economy with the rupee falling quite prodigiously and few solutions on hand. Quite clearly the MPC has preferred to look at the inflation target exclusively and pay less attention to the currency market where an increase in rates could have stalled the decline in FPI flows which are negative presently. Therefore, it does appear that there may not be too much of intervention of the RBI in the currency market which will find its own level.
Last the MPC has been relatively more sanguine on the quality of GDP growth where it expects capacity utilisation to improve in the second half, which is significant. While the rate did cross 75% in Q4-FY18, it was considered to be a year end phenomenon. If this does happen, it would be very positive for future growth prospects too and augurs well for FY20 growth.
Madan Sabnavis is chief economist, CARE Ratings. Views are personal.
By arrangement with Business Standard.