Monetary policy: RBI may explore prudent measures to raise credit offtake

It is now fairly obvious that Monetary Policy Committee (MPC) will choose to pause, adopt a watch and wait mode at this review. The MPC’s inflation targeting mandate will not allow otherwise, given multiple economic and policy indicators now publicly available. 

After the 7.35 per cent December CPI inflation print, we expect the January inflation once again to be close to 7 per cent, and then recede down to around 6 per cent for some months. While many vegetables prices have come off, other components of the food basket are creeping up.  In addition, Customs duties on a host of intermediates in many sectors have been raised, which will progressively feed into prices in FY21. The tax growth targets might imply the levy of additional taxes and surcharges on some consumables. The scope and pattern of rationalisation and changes in GST rates is unknown now but the overall mix might also be inflationary. 

Despite most published leading and concurrent economic indicators still showing signs of weakness, the January Purchasing Managers’ Index (PMI) printed at a surprising 55.3, the highest in eight years. Even if this rise turns out to be a one off, this will indicate caution.  As usual, the tone and language of policy will depend both on RBI’s own forecasts on growth and inflation as well as key updated responses on the household inflation expectations survey. This had moved up in the November round and is unlikely to have come off materially in January. The 5 per cent growth projection might be retained but CPI inflation for Q4 and H1 FY21 may inch higher. The decision is again likely to be unanimous. 

Might the likely persisting high inflation and expectations as well as potential green shoots induce a change in stance from accommodative to neutral? Very unlikely. Even other than the restrained fiscal stimulus approach, growth is unlikely to revive quickly.  The basic problem still remains constrained credit flows. Bank credit fell to 7.1 per cent as of January 17 and the offtake thus far in FY20 (April - January) has been only Rs 2 trillion (vs Rs 6.8  trillion in the same period the previous year). Issuances of commercial paper have shrunk deeply. Only onshore corporate bonds and offshore borrowings remain steady. There is a need to revive credit and, within prudent limits, probably look at micro prudential relaxations to encourage credit to segments which are starved of funds. However, this will be a very tricky exercise, and needs to be considered after significant due diligence, with little certainty of achieving results.  

Transmission to bank lending rates is progressing, but deposit rates and collections remain sticky. Small savings rates are unlikely to be cut, given their continuing importance in the Centre's borrowings. Continuing spends via public Financial Institutions and enterprises' bond issues will keep the pressure on interest rates.  Is the MPC likely to remain on a long pause? The statement and later minutes will indicate the thinking. Rate setting should preferably be stable and predictable, rather than change and be forced to reverse relatively quickly. 

The writer is chief economist, Axis Bank