Moneycontrol Pro Weekender: Have the facts changed? 

the RBI governor harped on the decision to keep rates unchanged being a one-off and the decision may change in future

Dear Reader,

What changed between the last two Monetary Policy Committee (MPC) meetings? Why did the MPC pause its rate hikes, contrary to expectations? Perhaps, as John Maynard Keynes is reported to have said, “When the facts change, I change my mind. What do you do, sir?” So, what facts have changed?

Well, India’s real GDP growth for FY24 is now pegged at 6.5 percent, compared to 6.4 percent at the MPC’s February 2023 meet. But that should have strengthened the case for a rate hike.

A twist in the tale comes from the inflation projections. Retail inflation is now projected at 5.2 percent for FY24, compared to 5.3 percent earlier. So, what the MPC seems to be saying here is the Indian economy will grow a bit faster, but with inflation a bit lower, so that’s perfectly fine and there’s no need for a rate hike.

But take a closer look at the quarterly projections and you’ll find the inflation projection for Q1 slightly higher, at 5.1 percent, compared to 5 percent earlier and the big change in inflation projections — from 5.6 percent to 5.2 percent — happens only in Q4 FY24. But that is because inflation has been higher than anticipated in Q4 of FY23 and therefore, the base effect will work in favour of headline inflation in Q4 FY24.

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Manas Chakravarty

Group Consulting Editor|Moneycontrol

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The RBI governor and the Monetary Policy Report have talked a lot about heightened uncertainty. Given this uncertainty, is it worth taking the risk of keeping the policy rate unchanged based on inflation projections a year down the line? After all, a year ago, the RBI had projected inflation at 5.1 percent in Q4 FY23 and the reality is that inflation is now above 6 percent, beyond the RBI’s upper limit. So, how is the MPC so sure that it will meet the inflation projection in Q4 this fiscal?

There’s some talk that the real policy rate is now high enough to warrant a pause, taking the real policy rate as the current rate minus one-year-ahead inflation. But one-year-ahead inflation will be lower only because of the base effect because inflation surprised to the upside in Q4 FY23.

To be sure, inflation is likely to be lower than 6 percent from March 2023 on because of the base effect. As Avalon Technologies IPO between March and October 2023, the statistical base effect would shave off 80 basis points from headline inflation on average.

It’s also possible that food prices may come down. But the RBI governor talked a lot about core inflation at the February meeting. This time, too, he said core inflation remains elevated and there is rigidity in core or underlying inflation pressures. And surely, if GDP growth is expected to be even firmer than previously envisaged, then the chances of core inflation remaining high are even greater.

Surprisingly, the governor quotes Kautilya as saying, “Be not slack before the whole job is finished.” Does the RBI think the whole job of containing inflation is finished then? The monetary policy review says that even in Q4 of FY25, retail inflation will be at 4.4 percent. Is bringing inflation down to 4 percent completely open-ended then, to be done at some unspecified point in future?

To be sure, the RBI governor harped on the decision to keep rates unchanged being a one-off and the decision may change in future. That is fine, but if the MPC can keep rates unchanged when the latest inflation print is 6.4 percent, it has enough excuse to not raise rates later this year when the base effect ensures that headline inflation comes down.

Why then did the MPC pause? Could financial stability be the reason? But the RBI has consistently said that Indian banks are in good shape. The government has also, by amending the capital gains treatment on debt funds, ensured there is no flight of bank deposits.

Could it be pressure from businesses and industry? Industry has been lobbying for a stop to rate hikes. And there is little doubt that small businesses are not doing too well. Perhaps, the fear is that higher interest rates could hurt growth and that a pause is in order for the lagged effect of previous rate hikes to do their work.

The real reason may lie in the headwinds being faced by the global economy. Economic forecasts by the World Bank and the IMF all talk of a sharp slowdown in global growth. Add to that the banking crises in the US and Europe and fears of a tightening of credit, which would further hurt growth -- this is a big change that has occurred after the last MPC meeting in February.

Most economists have pencilled in much lower growth for India than the RBI forecasts. For instance, Nomura Research, admittedly an outlier, believes India’s GDP growth in FY24 will be a mere 5.3 percent, which is why they expect 75 bps of rate cuts. Fed Funds futures indicate the markets believe the Fed too will be forced to cut rates this year.

Slower global growth would lower inflation, particularly for commodity-importing countries such as India. That is reflected in the RBI’s monetary policy report, which assumes a price of $85 per barrel in 2023-24 for the Indian oil basket, compared to $105 per barrel in the second half of 2022-23.

There’s also another reason to believe that inflation in India will remain low this year. The general elections are a year away and the government will do its best to ensure that food inflation remains low while it would like growth to stay strong. There is little the RBI can do about food inflation but the government can always import food products, place restrictions on exports and release more from buffer stocks to bring down prices.

Similarly, the government can also do a lot to ensure that fuel prices within the country do not go up. And finally, RBI surveys show that household inflation expectations have come down.

These considerations could have weighed on the central bank and the MPC while deciding on a pause in its rate hikes, despite strong growth momentum — seen from the PMI readings, elevated inflation — particularly core inflation, and risks such as higher oil prices and El Nino. Consider also what the JPMorgan Global Composite PMI for March says, “The rate of global economic expansion accelerated further at the end of the opening quarter, with growth of output and new orders hitting 9- and 12-month highs, respectively. Job creation also strengthened as companies forecast further output growth over the coming year.”

The decision, of course, is a gamble, which is why the RBI governor was at such great pains to make clear that “it’s a pause, not a pivot”. It could be a long pause.

Cheers,

Manas Chakravarty

Here are some of the stories and insights we published this week, apart from our technical picks in the equity, commodity and forex markets:

Stocks 

Is the tide turning in favour of banks?, Godrej Consumer Products, Which insurer’s stock offers better risk-reward trade-off?, What investors should do after the OPEC shocker, The outlook for the auto sector, Royal Orchid Hotels, Hindalco, Marico, Avalon Technologies IPO, Bharat Electronics, Cera Sanitaryware

Markets 

The impact of key near-term events on markets
Global asset returns show true market risk lies in complacency
Is a supercycle coming in oil markets?
Trapped short-sellers can take oil prices higher

Financial Times 

What I learnt from three banking crises
Millennials are not as badly-off as they think
Waging war on trade will be costly
The financial turmoil is not over

Companies and industry 

FMCG updates signal healthier margins
MSME loans a weak spot in banks’ asset quality
How Nvidia rebounded from the tech meltdown
Power Grid flexes its muscles
Maruti

Geopolitics 

The Eastern Window: Does Putin have a plan to counter the US?
India’s battery manufacturing plans will need a secure nickel supply chain

Policy 

As COVID cases mount, time to avoid past mistakes
SAT decision in Arshad Warsi case
Foreign trade policy

Economy 

Services exports the new hope, but not for all
India’s composite PMI

Charts of the Day 

Asia’s dividend kings rule the roost
Cotton mills to spin a happier tale
Passenger vehicles zoom past new milestones

Others 

Marketing Musings: Maggi’s time-tested lessons
Ram Navami violence in West Bengal
Startup Street: Will ‘down rounds’ be the next phase in Indian start-ups?
The importance of being Jack MaThe jobs market isn’t dead, it’s just growing differently