Status quo on interest rates, the best option

Anubhuti Sahay | Updated on January 09, 2018 Published on December 05, 2017

Shouldn’t go higher: With interest rates

While the monetary policy panel would be justified in being cautious, it should set at rest apprehensions on a future rate hike

The Hippocratic oath for new physicians emphasises that while dealing with problems, either help or do no harm. Adhering to this principle is likely to be the best strategy for the Monetary Policy Committee when it meets next week to decide on the repo rate. The consensus is that a status quo decision on the repo rate (currently at 6 per cent) is inevitable amid rising inflation, risks of fiscal slippage and a global environment where major central banks (and few Asian central banks) are hiking rates.

Compelling reasons

After the upside surprise in October CPI inflation, CPI is likely to remain at 4 per cent over the next six-to-nine months — in fact, the next two prints could be 4.5 per cent given recent rises in food prices. Since the MPC is mandated to keep headline CPI at 4 per cent on a medium-term basis, a status quo on rates would not be surprising. The argument for a status quo decision looks even more compelling if we focus on core CPI — a key metric watched by the MPC — which hit the 5 per cent mark for the first time after a gap of eight months. Additionally, it is expected to remain elevated at these levels for the next few quarters.

Non-negligible risks of fiscal slippage are yet another reason for our call for a status quo. Likely revenue shortfall on GST implementation, lower-than-expected dividend inflows from the Reserve Bank of India to the Government, and telecom sector-related proceeds are likely to lead to a temporary reversal in the fiscal consolidation process.

The FY18 fiscal deficit (Centre and States) is expected to be 6.3 per cent of GDP; this is wider than 6.2 per cent in FY17 (and much wider than the budgeted 5.9 per cent of GDP). Given the MPC’s sensitivity to fiscal slippage and the potential impact on inflationary pressures, a decision to stay put on rates would be prudent. Lastly, with lessons of the 2013 US taper tantrum uppermost in policymakers’ minds, the MPC is likely to stay cautious as major central banks normalise their monetary policy (especially tapering of its QE programme by the European Central Bank).

However, the MPC is unlikely to provide hawkish policy guidance amid rising inflation. It is true that CPI is rising; however, this is primarily driven by higher food prices (which can be seasonal), higher house rent allowance for Central government employees (a technical rather than an actual increase in rents), the asymmetrical impact of GST implementation (which should fade over the next few quarters) and adverse base effects; therefore it would be more rational to provide balanced guidance. Average CPI inflation in FY19 is unlikely to breach the MPC’s comfort level of 4 per cent amid a gradual growth recovery, excess capacity and limited pricing power.

Boost in sentiment

More importantly, after a series of bitter (but necessary) pills that significantly hurt economic momentum, sentiment has recently been boosted by the government’s efforts to recapitalise the banks and simplify/address operational issues in the GST framework. These measures have improved visibility on growth recovery.

It’s vital that improvement in confidence translates into higher private-sector investment and economic momentum. Keeping worries about a potential hike at a bay will be critical here — a hawkish stance could raise concerns and obstruct the much-awaited monetary policy transmission.

Recent comments from the RBI deputy governor in this context could provide some comfort. While re-emphasising the need for better transmission, Viral Acharya stated that monetary policy in India need not move in sync with others ( rate hikes by the Fed). A similar message to the market, especially when the economy is still in the process of stabilising after major policy changes, would be the most prudent approach.

The writer is head of economic research, South Asia, Standard Chartered Bank

Published on December 05, 2017
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