Extended pause ahead

In a move that had surprised the markets, the Monetary Policy Committee (MPC) had unanimously chosen to keep the repo rate unchanged at 5.15 per cent in the December 2019 policy review, given the lack of clarity on the evolving growth-inflation outlook, incomplete transmission of past monetary actions, and the growth-supportive measures that may be introduced in the Union Budget for FY21.

The MPC had sharply revised its CPI inflation forecast for H2FY20 to 5.1-4.7 per cent from 3.5-3.7 per cent, with risks broadly balanced. The subsequent inflation data was unpleasant, with a food price induced hardening of the CPI inflation from 4.6 per cent in October to 7.4 per cent in December, breaching the upper threshold of the MPC’S medium-term target of 4 +/-2 per cent.

Prices of some vegetables have corrected in January, aided by the rise in domestic supplies and imports of onions. The favourable rabi sowing trends, coupled with healthy reservoir levels, would support crop yields. However, the retail prices of pulses and oilseeds have seen an uptick. Further, the elevated global food price index poses a risk that needs to be watched. Also, telecom tariff hikes, rail fare hike, and an unfavourable base effect, are likely to push up the coreCPI inflation. In our assessment, the CPI inflation will print around 6.5 per cent in January, and fall gradually toward 4 per cent over the next three quarters, necessitating an upward revision in MPC’S inflation projections.

In December 2019, the MPC had reduced its projection for economic growth in FY20 to 5.0 per cent, from the October 2019 forecast of 6.1 per cent with risks evenly balanced. This was in line with the advance estimate of GDP growth of 5.0 per cent for FY20, released by the CSO in January. But the revised GDP data up to FY19, released subsequently by the CSO, indicates an implicit growth of 5.7 per cent for FY20.

In our view, the proposals made in the Union Budget for FY21 will not trigger a substantive revival in demand in the immediate term. However, recent high frequency indicators offer some evidence that in some sectors a gradual recovery has already set in, including the double-digit growth in Coal India’s output as well as the rise in the manufacturing PMI to an eight-year high level of 55.3 in January. The funding of the Centre’s fiscal deficit from the small savings pool is likely to go up from ~1.25 trillion in FY19 to ~2.4 trillion each in FY20 and FY21. This suggests small savings interest rates are unlikely to undergo any meaningful correction in the coming 4-5 quarters, irrespective of the policy action undertaken by the MPC.

Given the 135 bps of repo cuts undertaken in 2019 to support economic growth, we expect an extended pause from the MPC in H1CY20, until there is clear visibility of a fall in the headline CPI inflation below its medium-term target. Moreover, a change in stance to neutral from accommodative is anticipated in either the February or April reviews.