Run-up to monetary policy: Neutral is best gear for now, says Sonal Varma

What a difference a few months can make. Four changes, in particular, stand out. 

A synchronised global growth slowdown is now clear. Trade tensions, fading US fiscal stimulus, the effects of Chinese deleveraging, a slowing tech cycle are few of the reasons. 

Led by the US, China and euro area, we expect global GDP growth to slow to 3.4 per cent in 2019 from 3.9 per cent in 2018. For now, this is a cyclical slowdown, but downside risks have risen. 

Whether a dovish shift in global policy will suffice in countering these risks remains to be seen. 

Second, notwithstanding the gyrations, oil prices are down 28 per cent from their peak and 15 per cent from their 2018 average. Third, the Fed is now ‘patient’, as is the European Central Bank, implying a neutral monetary policy bias versus the more hawkish bent in 2018. 

Fourth, the Indian government announced an expansionary Budget. The cumulative effect of the cash transfer to farmers and the middle income class will be a boost to consumption, but likely at the cost of crowding out private investments. This growth mix could have adverse macro consequences. 

In other areas, it is more of the same. The divergence between low food and elevated core inflation continues. 

Sonal Varma

Momentum in core inflation has been particularly high. While this could partly reflect the lagged effects of higher oil prices and a weak currency amid strong growth last year, a significant part of the jump in core inflation appears to be driven by rural health and education. Generic medicine prices did rise, but the almost vertical climb in prices in mostly rural categories suggests something else is perhaps at play. If the rise is driven by a change in the agency that collects rural price data, then caution is warranted in drawing macro conclusions from these trends. 

The changing backdrop has important domestic implications. Ongoing political uncertainty and the global growth slowdown will result in a sharp slowdown in exports, manufacturing output growth and hurt investments. 

The growth composition may also change towards more consumption and less investment, as the former is boosted by lower oil prices and the farm focus of the government. 

Still, we doubt growth can hold up. We expect the GDP growth to remain below 7 per cent for much of 2019, in contrast with the Reserve Bank of India’s projection of 7-7.5 per cent. 

Weak global and local growth amid lower input costs suggest that current elevated core inflationary pressures are likely a passing phase, although the consumption-oriented stimulus announced by the government is possibly an upside risk that needs monitoring. Overall, though, we expect headline inflation to average below the medium-term target of 4 per cent in 2019. 

The policy implications are straightforward. The current policy stance of ‘calibrated tightening’ sits at odds with this shifting global backdrop (downside risk) and domestic fiscal stance (upside risk). Neutral is the best gear for now. 

As Bob Dylan put it more eloquently, “the times they are a-changin”.  

The author is Chief India Economist at Nomura