MPC to continue to wait & watch

The ongoing debate around India’s monetary policy is not whether the MPC will hike next week or not; but whether it will hike at all over the next twelve months or so. The reasons for such a debate are not surprising.

First, the Indian crude basket (ICB) is currently trading at levels (both in USD and INR terms) seen before the MPC hiked rates by 50bps. Second, even though a subdued CPI trajectory in the rest of FY19 is well anticipated, ongoing subdued food inflation has the potential to keep headline CPI muted in FY20 too. An uptick in food prices was expected in FY19 on higher crude oil prices (up an average 31% on a y/y basis), a weaker INR (up by an average c.8% on a y/y basis) and the announcement of higher procurement prices.

However, food inflation remains at a multi-years low of 1.8% y/y (April-October 2018), partially offsetting the rise in core inflation to 6.1%. Third, global growth is expected to have peaked and concerns about domestic growth on recent developments in the financial sector are leading to increased worries about whether pricing power can stay contained.

We agree that the MPC is likely to stay on hold when it announces its policy decision next week. We also expect it to retain its calibrated tightening stance and adopt a wait and watch mode amidst several uncertainties. However, calling for a prolonged pause as of now could be a hasty decision in our view.

Here, the MPC’s judicious decision to stay on pause at the October policy meeting despite oil prices trading at a high of USD85pb provides an important lesson.  Oil prices have been volatile in 2018 and in case of any supply-cut decision – OPEC meets on December 6 – could rebound too. It’s thus important to get clarity on this.

We believe that food prices are likely to pick up some momentum in FY20 on the lagged impact of higher oil prices – we expect oil prices to move above USD75pb – higher procurement prices and election related spending.   With a 46% weight in CPI, any uptick in food price momentum (even if it remains well below its historical average) could have a significant impact on headline CPI. We estimate that every 100bps increase in food inflation impacts headline CPI by c.45bps. Data prints over the next quarter and progress in terms of crop procurements at higher prices could provide better visibility on food prices in FY20.

Gaining clarity on global growth, likely action by major central banks and domestic growth will be crucial too. Along with expectations on future CPI, MPCs preference on real rates (stated in the range of 175-200bps in the past) plays an important role in determining monetary policy decisions. Should the MPC prefer real rates c. 200bps say on sharper than expected rate hikes by major central banks or risk aversion in global markets, it has the potential to trigger couple of hikes – we expect FY20 CPI at 4.9%. A clearer view on this however is likely to emerge over time and thus justifies a wait and watch stance again.

 
The author is Chief Economist, Standard Chartered Bank. Views expressed are personal

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