There has not been any surprise in the Monetary Policy Committee (MPC) action as the 7.4 per cent CPI inflation number for December provided little scope for going for a rate cut this time. The commentary of the Reserve Bank of India (RBI) is, however, important as it also takes into account the impact of the Union Budget while handing out the decision and here it is positive.
Inflation is likely to remain high in Q4 and the 6.5 per cent number provided is indicative of the fact that even in the next policy, it would be tough to cut rates as this number would be above 6 per cent. Combine this with the RBI projection of 4.5-5 per cent for H1, the feeling one gets is that inflation will prevail above the 4 per cent mark till September, 2020. A rate cut can still be done in case the MPC feels that growth is anaemic. Based on the RBI’s forecasts, inflation will moderate only in Q3 at 3.2 per cent. Here, too, the caveat of normal monsoon would hold.
While food inflation would moderate, the RBI has rightly pointed to the services segment which covers things like transport, telecom besides the higher customs rates pushing up consumer prices as being the risk factors. Even within food, the central bank has rightly noted that while vegetable prices would come down, the price of other products which are protein based have gone up, which can exert more continuous pressure on the inflation rate in the coming months. But non-food inflation will be something that will keep ticking in 2020-21.
On growth, the RBI is in line with the government as growth for next year has been placed at 6 per cent, which means that things will be better for sure relative to FY20, though the H2 will deliver higher growth compared with H1. Monsoon and spending patterns hold the clue for this to work out. Here, the RBI feels the government has done well for boosting consumption, which may not really work out as there is a divided view on this issue. However, their assumption is that the transmission of past cuts is working fine as seen in the weighted average lending rate (WALR) as well as the benchmarking of some retail and SME rates with approved securities. The assumption made is that the budgetary announcements on removal of exemptions will not counter some of these views. This has always been a worry when the Budget had announced the withdrawal of exemptions, especially housing and other savings in the alternative scheme propagated by the government.
The RBI has maintained an accommodative stance, which is good for the market as it rules out rate hikes which seemed possible at one time when inflation was going up (it probably will remain high for January, too). It has also indicated that there is room for further action, which means that during the year there will be some more rate cuts. More importantly, it is also asking for rates on small savings to be lowered as that would amplify the policy effects. The yield on the 10-year paper has come down marginally to 6.48 per cent from an opening of 6.50 per cent indicating a positive response from the market.
Madan Sabnavis is chief economist at CARE Ratings. Views are personal