The MPC has trimmed the policy
rate by 25 bps to 6.25% during the last MPC meeting of this fiscal year. Members
voted for a rate cut and expressed concerns regarding the subdued demand in
domestic as well as global markets. This comes after the Q3 CPI print came even
below the 2.7-3.2% target range that was set by the MPC amidst signs of decelerating
services and agriculture sectors. Headline CPI continues to languish with
downward pressures from food and fuel prices; now that the core inflation has
been exhibiting signs of sluggishness – a supply/ demand mismatch seems
apparent. Adding to the woes, the timing of it all couldn’t have been worse
given the global volatility.
On the domestic front, growth in IIP
index has dropped to an eighteen-months low of 0.5% in November, 2018 with the
fall in domestic consumption and exports. Similarly, headline inflation rate
has further decelerated to 2.05% in January, 2019 from a high of 4.9% in June,
2018. The high frequency data is corroborating well with the RBI’s Q3 OBICUS
survey, which states that the finished goods inventory to sales ratio has
escalated to 15.2 in Q2, FY19 from 13.4 in Q4, FY18. Another major indicator
for understanding the performance of an economy suggesting that the consumer
demand may be softening.
Putting thing into perspective, the
RBI is more concerned about falling demand that basically undermines growth
momentum in the short to medium term. The rate cut should therefore be seen as
a reaction to reinforce consumption. Under a weak economic sentiment,
stimulating growth is a major challenge before the government as well as the
monetary authority. While these may not warrant concerns pertaining to a
slowdown, the downward pressures indeed leave room for further rate cuts.
However, we are optimistic given
the tone of the Budget FY20, which has already placed a framework of an expansionary
fiscal policy. This will certainly frontload the system and bring back the
economy’s mainstay – consumption, back on track. We believe that an accommodative
monetary policy along with expansionary fiscal policy would sharply reverse the
inflation trend.
Having said that, one must
consider the international scene as well, which is showing increased sighs of
instability. As per World Bank’s monthly commodity price report for January, 2019,
the metal price index is on a downward roll over the past four months. Precious
metal price, in contrast, are on an upward trend. This gives a sense of mild
economic activities globally. China’s economic growth losing pace is a cause of
concern as well. Asian giant’s GDP growth rate has decelerated to a multi-year
low of 6.4% in Q3, 2018 along with the US escalating jobless claims, which are
indicating a fall in economic activity in that country.
The situation has resulted in a
flight to safety syndrome among global investors as seen in the US 10-year GSec
yield curve. The American yields have
dropped to 2.64% in the first week of February, 2019 from the highs of 3.22%
during end of October, 2018 symbolizing high demand for safe haven debt. Combined
with the rising demand for precious metals, the concerns regarding external
factors is actually real.
MPC is therefore stuck between a
hard place and a rock at the moment because in order to maintain an attractive
yield differential, a certain domestic rate has to be maintained without
ignoring domestic conditions real. The current fiscal expansionary policy may
help this cause but we are sceptical regarding the timelines which are still
unclear and difficult to predict.