Growth imperatives

The first monetary policy decision of FY2020 that will be rolled out in a couple of days is surrounded by significantly lower uncertainty about the rate decision by the MPC. The current rhetoric emanating from the Committee seems to indicate that if the inflation trajectory remains benign and under control for the foreseeable future then growth concerns can take precedence.

The CPI trajectory primarily that of food inflation has undershot expectations repeatedly and seems likely to be well contained going forward. Our projections suggest that CPI is likely to average 3.8 per cent YoY in FY2020 with the food price index reverting from contraction that was witnessed in the last few months while core inflation shows signs of moving lower.

The MPC has also evinced confidence on fiscal consolidation and its minimal impact on inflationary expectations.

Moving on to growth prospects, our proprietary model indices tracking monthly high frequency indicators suggest that while there was some tentative recovery in December 2018 the momentum seems to have decisively slowed.

Headline GDP growth has been falling for a few quarters now and the Q3 FY2019 outcome was a meagre 6.6 per cent YoY. Our models show that Q4 FY2019 is likely to register an even lower headline GDP growth. Within this, consumption seems to be witnessing a continued decline.

Investment is showing nascent signs of revival but much of it is driven by the public sector while the private sector long cycle capex recovery still seems some way off. This growth-inflation mix, suggests that slack in the economy may be growing as reflected by a growing output gap leading to a likely revision in growth forecasts, thereby generating space for policy accommodation.

While a 50 bps rate cut cannot be ruled out we do believe that the MPC would deliver 25 in this policy.

The real debate in this policy will be on the accompanying rate stance and liquidity stance. While the MPC changed its stance in February to “neutral” from “calibrated tightening” we do assign a higher probability to a further change in stance to “accommodative”.

The change would not be hard to justify in light of the substantial spin that we have seen in global monetary policy in the last two months, against the backdrop of growing concerns about global growth, falling manufacturing and sentiment indices, inversion of the yield curve in the US and increasing amount of bonds trading in negative yields territory. Given the fact that monetary policy making is also a prisoner to the uncertainty of oil prices, the MPC may still choose to retain the flexibility that is afforded by a “neutral” stance.

Liquidity issue

Domestic systemic liquidity will remain the key variable that will probably affect transmission even more than a rate cut but it is not explicitly under the MPC’s remit. F FY2020 is also likely to see substantial currency leakage although this time we expect a balance of payments surplus which will alleviate the situation somewhat. Even then, there will be need for substantial liquidity injection.

The RBI recently introduced the long-term forex swap tool which can also infuse rupee liquidity into the system. Overall, bond markets would be well supported by benign inflation, slowing growth and accommodative monetary policy while rising oil prices and heavy bond supply could keep them cautious.

The writer is Head, Global Markets Group, ICICI

COMMENT NOW