The recently released Q2FY20 GDP at 4.5 percent further highlights the deepening concerns on growth. This is in contrast to RBI’s estimates of 5.3 percent.
The recent October consumer price index (CPI) print breached the RBI Monetary Policy Committee's (MPC) medium-term inflation target of 4 percent and their estimate, as set in the previous policy by over 60bps.
The October inflation of 4.6 percent overshot the 4 percent mark for the first time since July 2018. Given the continued spike in vegetable prices, headline CPI inflation would track 5.3 percent in the coming month.
To evaluate the MPC’s decision in the backdrop of an uptrend in headline CPI it may be important to look at the internals of the inflation prints and their sustainability.
Firstly, despite the high headline CPI print, the October CPI inflation excluding vegetable remains fairly stable and benign at 3.2 percent. Given the adverse supply shocks arising from unseasonal rains and transportation issues, vegetable price inflation has surged significantly.
We expect this supply shock to ease in the coming months. With improved winter supply, we see food inflation moderating from near 10 percent in November 2019 to 6 percent by March 2020. Meanwhile, the wholesale price index (WPI) inflation trajectory also continues to point towards the fading pricing power of manufacturers.
Secondly, the core inflation collapsed from this years’ high of 4.6 percent in April 2019 to 3.3 percent in October mirroring the persistence of weak growth momentum. The slowdown is becoming increasingly broad-based and entrenched as indicated by the high-frequency data.
The recent September IIP growth contracted by 4.3 percent, taking the Q2FY20 industrial activity growth to (-) 0.4 percent as against 3 percent in Q1FY20.
The recently released Q2FY20 GDP at 4.5 percent further highlights the deepening concerns on growth. This is in contrast to RBI’s 5.3 percent estimate.
With limited fiscal headroom, existing slack and ensuing credit crisis hindering monetary transmission, we expect the next few quarters also to remain lacklustre. Clearly, RBI’s FY20 GDP estimates of 6.1 percent will need to undergo sharp downward revisions.
With widening negative output gaps and weakening core inflation, we expect the MPC to assign a higher weight to address growth concerns.
While we reckon that the MPC’s mandate is to manage the headline CPI inflation around 4 percent which seems to be deflecting from its medium-term target in the near future, we expect the MPC to make note of the expected reversal of the transient spike in food prices thus easing the headline inflation after few months.
The ‘flexibility’ of inflation targeting will truly be tested on the trade-off between growth and inflation, which could result in a split vote as some members may prefer to wait to assess the food price trajectory and evaluate the impact of earlier rate cuts before easing any further.
However, we expect growth concerns to dominate and continue to pen down a cumulative 50bps rate cut in the rest of FY20 and a 25bps of a repo rate cut in the December policy itself.
The author is an Economist at Kotak Mahindra Bank.Disclaimer: The views and investment tips expressed by investment experts on moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.LIVE NOW... Video series on How to Double Your Monthly Income... where Rahul Shah, Ex-Swiss Investment Banker and one of India's leading experts on wealth building, reveals his secret strategies for the first time ever. Register here to watch it for FREE.