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 recent October CPI print breached the medium-term inflation target of 4 percent, set by the monetary policy committee (MPC), and its estimates set in the previous policy by over 60bps.
The October inflation of 4.6 percent has overshot the 4 percent mark for the first time since July 2018. Given the continuing spike in vegetable prices, the headline CPI inflation seems to be tracking 5.3 percent in the coming months.
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 vegetables remains fairly stable and benign at 3.2 percent.
Given the adverse supply shocks arising from unseasonal rains and transportation issues, the 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 around 10 percent in November to about 6 percent by March 2020.
Meanwhile, the WPI inflation trajectory also continues to point towards a fading pricing power of the manufacturers.
Secondly, the core inflation has been collapsing 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 2QFY20 industrial activity growth to (-) 0.4 percent as against 3 percent in 1QFY20.
The recently-released 2QFY20 GDP at 4.5 percent further highlights the deepening concerns on growth. This is in contrast to RBI’s estimates of 5.3 percent.
With limited fiscal headroom, the existing slack and ensuing credit crisis hindering the monetary transmission, we expect the next few quarters to remain lacklustre. Clearly, the 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 higher weightage to addressing 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 a 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 Economist, 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.Are you happy with your current monthly income? Do you know you can double it without working extra hours or asking for a raise? Rahul Shah, one of the India's leading expert on wealth building, has created a strategy which makes it possible... in just a short few years. You can know his secrets in his FREE video series airing between 12th to 17th December. You can reserve your free seat here.