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13 Feb 2019


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.