No rate action till February

The Reserve Bank of India may revise both inflation and growth projections downwards

On October 5, when the Reserve Bank of India (RBI) announced its last bi-monthly monetary policy after a three-day meeting of its monetary policy committee (MPC), the rupee touched a low of 74.22 to a dollar, before closing at 73.77. Within a week, the local currency lost even further — 74.48 to a dollar. Last week, it ended at 69.60.

The price of crude has dropped 30 per cent since October 5 — from $84.16 a gallon to $58.80, its one-year low. 

The yield on 10-year paper which closed at 8.04 per cent on October 5 (after a high of 8.25 per cent in September), last week closed at 7.61 per cent. At the shorter end, the 364-day treasury bill yield had dropped from 7.77 per cent to 7.23 per cent during this period.

The year-on-year credit growth in the banking system is 14.9 per cent till early November, against 8.3 per cent last year.

Most importantly, retail inflation dropped to 3.31 per cent in October, from 3.77 per cent in September. Going by most analysts’ estimates, it will drop below 3 per cent in November.

The softening of crude prices will bring down the core inflation too in the coming months as the lower fuel price will feed in

And, of course, there are signs of global growth slowing down and the US Federal Reserve is changing its tone. It is expected to go for the fourth rate hike in December but will be flexible on plans to raise rates in 2019.

In cricket parlance, it’s a dream pitch to bat on for a central bank of a country where the economy is driven primarily by domestic demands. For sure, RBI will not touch its policy rate on December 5 when the MPC concludes its latest meeting, the fifth in fiscal year 2019.

After two successive rate hikes in June and August, the RBI opted to maintain the status quo in October but changed the stance of the policy from “neutral” to “a calibrated tightening”, indicating rate hikes in the future. In retrospect, one may say that the RBI should not have changed the stance in October. But, had it not done that, it would have lost its credibility, when most analysts were predicting a rate hike. It is unlikely that it will change its stance back to neutral this week but the Indian central bank is likely to be in a mode of a prolong pause, at least till February when it is likely to change the stance back to neutral. After that, it’s anybody’s guess. 

Meanwhile, the one-year overnight indexed swap, a derivative gauge where investors exchange fixed rates for floating payments, is indicating one rate hike in fiscal 2020. In October, it was pricing in two rate hikes by December and three to four rate hikes in next one year. 

Despite the rise in crude prices and a depreciating currency as well as increase in minimum support prices of crops and house rent allowances of government employees, the RBI did not hike the rate last time; it preferred to watch and watch with a tightening stance. It projected 3.9-4.5 per cent retail inflation in the second half of fiscal year 2018-19, and 4.8 per cent in the first quarter of 2019-20, lower than August policy projections. But now the upside risks to the projections do not seem to exist and, in all probability, these projections will undershoot. I will not be surprised if the RBI brings down its inflation projection for the second half of the current year. The MPC’s objective is achieving the medium-term target of 4 per cent retail inflation with a (+/-) 2 per cent band.

Driven by unseasonal decline in food prices, the headline retail inflation fell to its one-year low in October but the so-called core inflation or non-food, non-oil inflation, increased to 6.2 per cent year-on-year in October from 5.8 per cent in September. The softening of crude prices will bring down the core inflation too in the coming months as the lower fuel price will feed in. 

The RBI could revise its growth projection too downwards. In its October monetary policy statement, it kept the growth projection for 2018-19 at 7.4 per cent (with risks evenly balanced), unchanged from its August estimate. Now that the September quarter figure is lower than the RBI projection (7.4 per cent), in all likelihood, it will pare its estimate, since in the second half, GDP growth is likely to be lower than the RBI estimate of 7.1-7.3 per cent.

The GDP growth in the September quarter slowed to 7.1 per cent, as agriculture and other private sector activities contracted despite strong government spending. It is much lower than consensus estimate and June quarter’s growth of 8.2 per cent. Indeed, the high-frequency data such as two-wheeler and auto sales have been indicating a slowdown, but none expected the growth figure to drop to this level. The scene could worsen, leading to clamour for a rate cut (with the shadow of general elections looming large) but the RBI may decide to wait for the April policy for action as the December quarter GDP figure will be released in the last week of February, weeks after the RBI’s next policy. 

In the October policy statement, there was a tinge of worry on growth but the causes for worry were different. While there will be a pause at least till February, the RBI will remain active in managing liquidity in the system. It has already infused close to Rs 1.37 trillion through selling bonds under its so-called open market operations (OMOs) this year and another Rs 400 billion will be infused in December. Systemic liquidity deficit last week was around Rs 840 billion.

There are three ways the RBI can infuse liquidity. One, by cutting banks’ cash reserve ratio (CRR) or the portion of deposits that commercial banks need to keep with the central bank; two, through OMOs and, three, buying dollars from the market (for every dollar the RBI buys, an equivalent amount of rupee flows into the system). The RBI has sold at least $29 billion this year since April to iron out volatility in the foreign exchange market (for every dollar it sells, an equivalent amount of rupee gets sucked out from the system). 

A cut in CRR can be ruled out; the RBI may resume dollar buying if the local currency strengthens further but, for the time being, it will continue with its OMOs.

In the current context, it will be interesting to see how the policy statement takes note of the fiscal worry — the government breaching the fiscal deficit target for full year in seven months. 

The columnist, a consulting editor of Business Standard, is an author and senior adviser to Jana Small Finance Bank Ltd. 

Twitter: @TamalBandyo