Opinion | Growth tilt distinct
3 min read . Updated: 04 Apr 2019, 05:30 PM ISTWhile one more rate cut is within the realms of possibility in 2019, data will hold sway
Slowing growth, low inflation, and an increasingly dovish US Federal Reserve stance had created elbowroom for the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) to cut the repo rate during its monetary policy review meeting on Thursday.
In the context, the 25 basis points cut in the repo rate was not a surprise.
The MPC statement also reiterated sharp focus on liquidity, as evinced in the highly successful dollar-rupee swap operations.
The RBI also lowered its forecast of India’s economic growth by 20 basis points to 7.2% for fiscal 2020.
High uncertainty and the data-driven nature of monetary policy – which seems to be the norm rather than exception globally – means surprises cannot be ruled out, going ahead.
Recent communications from major central banks reflect this.
A few days back, the European Central Bank, during its monetary policy review, noted, “In a dark room, you move with small steps".
In August, 2018, Fed Chairman Jerome Powell, in his address at Jackson Hole, Wyoming, US, talked about monetary policy making being akin to ‘navigating with stars when the stars are shifting’.
The current worry for central banks in advanced countries is growth rather than inflation and both the ECB and the Fed are unlikely to raise interest rates this year.
While the same is true also in India, inflation could surprise here for indigenous reasons. In the past three fiscals, it was low food inflation – normally an idiosyncratic/ luck factor – and not economic slack, that restrained the headline number.
Indeed, this pattern is not new. Since 1991, almost all the cyclical ups and downs in inflation correlate with similar cycles in food inflation. The most notable of them is the period between fiscals 2000 and 2006, when the overall consumer price index (CPI) and food inflation averaged 3.9% and 2%, respectively.
That also means inflation will inch up once we run out of luck on food inflation.
Two factors that can drive this are the low-base effect and inadequate monsoon. Plus, wholesale prices/mandi prices of some of the food items have already started moving up and crossed their Minimum Support Prices and this will soon reflect on consumer prices as well, given that WPI food inflation impacts CPI food inflation with a lag.
Food inflation, with 40% weight in CPI, dropped from 4.9% to 0.2% between fiscals 2016 and 2019. It is likely to move up from the low base as normalcy returns to food prices in fiscal 2020.
What can hasten the ascent is a monsoon shock emanating most probably from an El Nino event. The fiscal policy, too, could pose risks to inflation going ahead.
The World Bank too has said that global food prices should rise in 2019.
Core inflation, which strips out food and fuel, and reflects the economic slack, has remained sticky, in the 4.4-5.5% band in the past five years. It has contributed almost 80% to overall inflation in the first eleven months of fiscal 2019. According to the RBI, output gap typically affects core inflation with a 3-5 quarter lag. So, there would be some softening of core inflation from 5.5% currently.
The good news is, despite the expected pick-up in food inflation, we forecast consumer inflation averaging 4.5% in fiscal 2020, which would be well within the central bank’s target.
The RBI does not see food inflation as a material risk at this juncture. Continued undershooting of inflation and lowering of household inflationary expectations led the RBI to moderate its inflation outlook further.
When uncertainty is high and there are challenges in understanding the process and trajectory of inflation, central banks are more likely to be reactive rather than pre-emptive.
While one more rate cut is within the realms of possibility in 2019, data will hold sway.
Dharmakirti Joshi is chief economist, CRISIL