CNBC-TV18's Citizens' Monetary Policy Committee: Here's what to expect

Varma: Actually, the numbers in the January-March quarter finally confirmed two-three things. One is that yes, demonetisation did have a significant impact on economic activity. Second, the growth numbers are actually now finally consistent with what we have been seeing on the real activity front in terms of monthly indicators. Third, this is now consistent and now makes clear why core inflation momentum has suddenly softened so dramatically since demonetisation because post November, the continued downside surprise has also led to questions of whether the core inflation downtrend is structural in nature and what the GDP numbers now basically are telling us is that both growth and inflation are seeing the effects of demonetisation. So it actually ties in very well together.

Now the question is what lies ahead, and the indicators starting in March broadly have been suggesting an improvement and a recovery from the demonetisation shock. Remonetisation has continued, rural demand, urban demand, certain services sectors are starting to revert back to the pre-demonetisation level numbers. Therefore, this is ultimately a transitory shock and despite the downside surprise, should not have much material impact on the policy outlook.

Q: Would you agree with Sonal? How do you see the growth-inflation dynamics?

Chinoy: Two things came out quite clearly from the GDP data. The first was that even though the focus is very much on the impact of demonetisation, the fact is growth began to slow in the quarters well before demonetisation. So the first judgement the MPC has to make is how much of the slowdown in the second half was simply a continuation of a process that started before and therefore, could be more enduring and more ominous and how much of this was just transitory because of demonetisation that is going to reverse.

My own sense is that growth has been relatively weak for much of the last year and the proof of the pudding is in the eating. The fact that core inflation, when measured correctly, has been falling, has fallen another 100 basis points over 2016, just adds more credence to the view that growth had been slowing more secularly and therefore, we should be a little bit cautious about expecting a very sharp recovery.

The second point is we finally have a consistent macroeconomic narrative which we may not like, but it is consistent that as Sonal said, the GDP data, the high-frequency data, pricing power, core inflation are all suggestive of a slowdown. The most, important part however is, the MPC will be guided by where the inflation outlook. Growth only matters to the extent that it affects their inflation outlook.

What I struck by in the last MPC minutes was this was a committee that was firmly focused on upside inflation risks and those emanated from three sources. One was the output gap would close and core inflation which had been very sticky in their view, would remain that way. Second was everyone expected a sharp mean reversion of food prices. Third was the house rent allowance (HRA) was part of the Pay Commission.

At least on the first two factors, there is progressively more comfort that those risks will not manifest and therefore, inflation could potentially meaningfully undershoot the RBI's forecast. A secular and sustained disinflation of food may have more of a structural component than several of us had given it credit for.

So, if some of this food disinflation is structural and sustains and we have another year where growth is not accelerating sharply and therefore, core inflation remains contained, we could be in a situation here wherein our own forecasts, consumer price index (CPI) in the first six months of the year averages less than 3 percent and in the next six months, averages less than 4 percent. So that is going to be the challenge for the MPC that we could be in a situation where inflation could meaningfully undershoot the forecast they had earlier in the year.

Q: It looks like these are two opposite points of view. Sonal saying that the GDP and the inflation fall could be transitory because of demonetisation and Sajjid saying that no, it began earlier and is perhaps structural, the disinflation and the slowdown. What are your thoughts?

Sen: In a sense, both are right because what we did know for a while was that rural India was suffering and has been suffering for about two years. So, the structural component in terms of the longer-term deceleration of the economy was probably largely driven by that factor. However, when we come to the last two quarters, we have two contradictory forces operating. One is, we had an excellent monsoon, very good agricultural response which takes care partly of the rural distress that was being experienced earlier and on the other hand you have the effect of demonetisation.

So when you look ahead, the question that one needs to ask is whether the drivers of demand are back in place. Now that is dependent on two things. One of course is what is going to happen to monsoons, if it is good then hopefully rural demand will continue to pick up. Second is that the big intervention that the government has made in terms of trying to revive activity, revive demand in the economy is really to push the Mudra loan much further and so create a lot of self-employment in the country and hopefully get demand back up.

So we are in a situation where there are two question marks and the way you think about the two of them would have to be different.

Q: Some ground has been covered. Where would you stand in terms of what more factors the MPC may watch?

Chakraborty: If you look at it, Sonal and Sajjid were talking more on the core inflation side of things and how it has been slowly coming down based on the output capital not closing as much as RBI was anticipating, but it is equally important to look at the food inflation part of it and if you look at just the Department of Consumer Affairs (DCA) data on food prices, for 10 consecutive months now, there is a month-on-month decline. I cannot imagine this happening ever before. If you just look at absolute level of prices for vegetables, they are at the level where they were three years back. So something has changed and we cannot just forecast food inflation based on past trends. So either we take the view that it is going to mean revert or we take a completely different view that this is structural in nature.

The other thing that is going to be important is that between June and August, next policy, there are quite a few one-off factors that are going to drive inflation. You are going to see the monsoon, you are going to see the minimum support price (msp) increase, you are going to see goods and services tax (GST) introduction, you are going to see probably the HRA increase coming in, so the question should be that should we wait for some of these things to play out before taking a firm call on the inflation trajectory or we get bold and change the inflation trajectory based on whatever we have seen in the last couple of months. That is the debate that the MPC will have to do.

Q: Let me start with the one-offs then. The current Governor, then Deputy Governor, had, if I remember right, indicated that we have to maybe look through at least the Seventh Pay Commission impact. GST perhaps, you cannot look through; it may be a little longer. What is your sense, besides the current inflation-growth dynamics, will these one-offs be treacherous enough to push up inflation, remove the structural slowdown?

Ghosh: In terms of the inflation dynamics, let me concentrate on the one-off factors. If you look into the last MPC meetings, they have flat four or five risks. One was the oil, other was the GST, another was the food inflation, another was the imported inflation and another was Pay Commission recommendation. Now if I just pick up the Pay Commission recommendations, they have not yet been implemented. If I am correct, that is still being in the discussions and the government is mindful that these changes could impact the headline inflation numbers. So as long as something is not done, we should not bother too much about it.

My sense is that, now the impact, even if it is there, it could be spread over a period of months. Earlier we were talking about a 100 basis point impact, now the impact could be limited and it could be spread over six months. This is the first one-off factor.

Q: GST impact?

Ghosh: GST in fact, we looked into the rates and in our case we find that the GST could actually have a new neutral to downside impact on the CPI headline numbers because if you look at some of the commodities like pulses which is actually driving the inflation rate down significantly in terms of a negative weighted contribution, the rate is actually zero. So, some of these could actually even push the inflation rate meaningfully lower in the next couple of months.

Then there is the impact of oil. Oil prices are now; there is a general consensus that they will be capped at USD 50 per barrel or more. Food inflation, as Samiran was saying, if you actually look into sequential, non-adjusted month-on-month increase of cereals, pulses, protein, they are significantly less than what they were 2-3 years back and also the imported inflation because of the rupee. So in all my sense, even those factors which could be transient in nature could have a favourable impact on the inflation trajectory going forward.

Q: You did say that the Mudra loan increases and the diminishing of rural distress will put more demand into this system. There is also the increased trade deficit because of a strong rupee maybe, something which I just wanted to highlight to you. But how should the RBI react to all this?

Sen: It is not necessarily that the Mudra loan and reduction of rural distress will lead to the desired result, because you can actually get further worsening of the food prices and agri prices in general, so one needs to be a little careful. We also have to be mindful of the fact that fixed capital formation has been declining steadily for a while. Now, we are firmly below 30 percent and that is something that should be concerning people. This is the time to actually try and consolidate the initiatives that the government has taken to revive demand in the economy. So if I were the RBI, I would be thinking ahead of the curve and really this is a time where I would certainly shift out of the neutral stance and move to accommodative.

Q: Would you go that far?

Chakraborty: To my mind, if you look at the April-June policy, growth data has been softer, inflation rate is softer, global economy better from an inflation sense, if not worse. The challenge really is that how quickly should RBI respond and from a communication perspective, it should not look like there is a complete turnaround immediately within two months from the somewhat markets interpreted hawkish stance in April.

So, we have put in about a 40 percent probability, very subjective one, on even a possibility of a rate cut in the June policy. But still our base case seems to be that RBI will wait for some of these one-off factors that we were discussing to play out before taking a firm call on how much easing will be required. Our sense also is that this is one of those times when RBI can use the flexibility that it had talked about earlier which is that even with a neutral stance, you have two way flexibility of moving rates. So it is not that necessarily that the stance needs to be changed for a particular rate action to happen.

Q: What else should they bring to bear in terms of an action?

Ghosh: The first thing the MPC, after deliberation, should do is to give out a statement in terms of the policy which shows that it is more dovish in nature because if we look into the past trends, the current data, and at least two things I would like to point out. The first thing is that there is still a significant amount of liquidity sloshing in the system. If you look into the incremental credit and the incremental deposits and if you take out the incremental credit from the deposits, still Rs 2.7 lakh crore is actually there in the system and add to that another Rs 1 lakh crore which has come in through the 15 billion capital inflows in the last four months. So that makes the job of RBI a little bit easier because if the RBI gives the signal to the market that it is in a mode whereby the price will be dovish, the interest rate will definitely move down. This is the first thing.

The second thing that the central bank should actually do, it should look at the inflation forecasts a little better. Possibly, it could give out some strategy in terms of a short-term and long-term forecast because every time there is a long-term forecast on inflation that is difficult to interpret because the oil prices, nobody has a take on oil prices, how they are going to behave in the next 12-14 months. So maybe, a move to some sort of a short-term strategy in terms of inflation forecasting could give the market a better handle on the price expectations and the numbers going forward.

Q: To get back to the point that Samiran also said. The RBI, only in February moved from accommodative to neutral. Do you think they can track back this early or would you think that first they prepare the ground and then perhaps take the call?

Sen: The point is that as Samiran rightly said neutral means you can move either way. The problem with that is that if supposing you do move towards an expansionary monetary stance, you are not actually letting people know. You are then allowing the market to work its way through and then having whatever macroeconomic effects it has without really affecting expectations at all. The point is that in a situation where there may be legitimate fears that prices would fall even further, we need to allay those apprehensions.

Therefore, I do not think a rate cut makes sense at this stage. That can wait, but at least the stance should change. You should not get stuck up on egos.

Q: On June 7, are you expecting a cut, a pause or a hike? I guess, from the way you have spoken, a hike is a little difficult to expect, but is it a cut or is it a pause?

Chakraborty: Pause.

Ghosh: Pause.

Sen: Hold.

Q: What would be the stance or the tone? The stance may remain the same, but if you still think the tone would change, do let us know is it dovish, is it neutral, is it hawkish, what would the tone of the MPC be?

Chakraborty: Softer than April.

Ghosh: Neutral to downside.

Sen: Accommodative.

Q: For the rest of 2017, would you see a cut or a hike or a long pause? What is the expectation for the rest of 2017?

Chakraborty: No change as of now.

Ghosh: Rate action more towards a change which is a cut.

Sen: Cautious.