The Reserve Bank of India’s (RBI) monetary policy committee (MPC), chaired by governor Shaktikanta Das has announced consecutive repo rate cuts between February to October with an accommodative stance to revive growth. Following the fifth rate cut in a row in October, market participants were expecting a similar rate-cut action from the December MPC meeting held at the central bank’s headquarters in Mumbai. The MPC, however, delivered a surprise status-quo on the rate action.

In the recently published minutes of the MPC meeting held during December 3 to 5, the committee said the RBI can reduce interest rates further but high inflation called for a status quo on rates in December.

The committee highlighted that consumer price inflation (CPI) was projected at 3.4% for the second quarter of FY20, 3.5-3.7% for second half of FY20 and 3.6% for the first quarter of FY21 with risks evenly balanced. According to the MPC, the actual inflation outcome for Q2 evolved broadly in line with projections–averaging 3.5%.

“The inflation print for October, however, was much higher than expected.”

The committee was of the opinion that going forward, the inflation outlook is likely to be influenced by several factors, including the upsurge in prices of vegetables, and incipient price pressures seen in other food items such as milk, pulses, and sugar which are likely to be sustained. Furthermore, domestic demand has slowed down, which is being reflected in the softening of inflation excluding food and fuel.

“Taking into consideration these factors, the CPI inflation projection is revised upwards to 5.1-4.7% for H2: FY20 and 4-3.8% for H1: FY21, with risks broadly balanced,” the MPC noted.

On the economic growth front, real GDP growth for FY20 in the October policy was projected at 6.1– 5.3% in the second quarter of FY20 and in the range of 6.6-7.2% for the second half of FY20 – with risks evenly balanced; and 7.2% for the first quarter of FY21.

“GDP growth for Q2: FY20 turned out to be significantly lower than projected,” the MPC said. “Various high-frequency indicators suggest that domestic and external demand conditions have remained weak.”

The MPC also noted that the monetary policy easing since February 2019 and the measures initiated by the government over the last few months are expected to revive sentiment and spur domestic demand. Taking into consideration these factors, the MPC revised downwards the real GDP growth for FY20 from 6.1% in the October policy to 5.0% – 4.9-5.5% in the second half and 5.9-6.3% for first half of FY21.

At the MPC meeting, Das said, “Overall, several uncertainties cloud the growth-inflation outlook.” He was of the view that the surge in food inflation in the last three months could be transitory, as it was driven up by a spike in onion and other vegetable prices which could likely reverse gradually as late kharif output comes to the market.

At the meeting, MPC member Bibhu Prasad Kanungo pointed out that the committee has cumulatively reduced the repo rate by 135 basis points (100 basis points make a percent) and its impact of will gradually be felt on the real economy. “The current uptick in inflation driven by a sharp increase in food prices is expected to reverse,” Kanungo said. “Even as space exists for future monetary policy action, a pause at this juncture would help calibrate the appropriate policy response in future.” He also voted for “persevering with the accommodative stance as long as it is necessary to revive growth while ensuring that inflation remains within the target”.

In a note from Kotak Securities, three authors led by Kotak Mahindra Bank’s senior economist Upasana Bhardwaj, said that the minutes of meeting reflected the limited flexibility the MPC has in addressing the growth slowdown at a time of rising inflation. “In fact, most members chose to keep the repo rate on hold before the budget, hoping that the government would do the heavy lifting in an attempt to revive the economy,” the analysts noted.

“Meanwhile, core CPI inflation will likely increase owing from December/January due to recent telecom tariff hikes pushing headline CPI inflation trend closer to 6% in the near term,” the analysts said.

They expect CPI inflation to moderate towards 4.9% by March as food prices moderate in the first quarter of FY20. On the policy front, the trio’s projections suggest that inflation would likely remain 90-185 basis points higher than the MPC’s comfort zone till March 2020.

In a December 19 note, Nomura economists Sonal Varma and Aurodeep Nandi, said that the MPC members underlined the need for more clarity on growth, inflation, policy transmission and government action before committing to further easing, suggesting that monetary policy has already delivered its adequate share of growth heavy-lifting as of now.

“Nevertheless, appetite for policy easing hasn’t entirely been lost, though at present the MPC can offer little in terms of further guidance on the space and timing of it,” the analysts wrote.

The Nomura economists believe that the phase of stagflation is likely to be a temporary one, and short-term supply-side shocks should calm by Q2. “Once vegetable supplies normalise, big corrections in prices should follow, limiting the risk of a blow up in the headline print,” they noted.

They also expect sluggish monetary policy transmission to bank lending rates given the pause in easing. “Once the dust settles on these transitory factors, we believe the urgency of resuscitating sagging growth momentum will again dawn on the MPC,” the analysts said. “In our view, this should result in another 25 basis point easing in Q2.”

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