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Odds in favour of pause; MPC likely to be split
At the first bi-monthly monetary policy for FY20 to be held during Apr 2-4, we expect the Monetary Policy Committee (MPC) to hold rates. Below, we elaborate on the reasons:
* Inflation likely to pick up:
CPI inflation fell to its 19-month low of 1.97% in Jan ’19 before increasing to 2.6% in Feb ’19. The ~60bps sequential increase in headline inflation was almost singlehandedly driven by rising food prices. The drivers of food disinflation so far viz. pulses, sugar and vegetables are unlikely to drive further disinflation. Daily food price data shows that pulses prices have started rising while prices of vegetables and sugar have stabilized. Hence, we expect food inflation to print positive in Mar ’19 after five consecutive months of negative prints. Moreover, base effect is expected to turn unfavourable in April and remain so till Nov ’19. Hence, the double whammy of rising food prices and large negative base effect is likely to push up inflation quickly. We expect Mar ’19 headline inflation to print ~2.86%, taking average inflation for FY19 to 3.43%.
* Softening core inflation hides poor internals:
Although core inflation is easing, the internals don’t look promising. Large part of decline in core inflation over the past few months is driven by lower housing costs as the HRA hike-induced increase in housing inflation faded out of CPI calculation completely from Dec ’18. On the other hand, services such as healthcare and education are registering sharp and secular increase indicating underlying inflationary pressures.
* Election-related spending and income support schemes:
In the run up to elections, various political parties have announced income support packages e.g. BJP’s KISAN and Congress’ NYAY. These schemes offer unconditional transfer of money to targeted individuals/households which could feed into inflation in the coming months. Also, large-scale election-related spending could be inflationary
* Possibility of deficient monsoon:
The IMD recently declared that weak El-Nino conditions are prevalent in Pacific Ocean. El Nino conditions in India are typically associated with below-normal monsoon rainfall. If El Nino materializes, it could have an impact on food production in the country and eventually food prices
* Split MPC:
In the last monetary policy review, despite multi-month low inflation two members (Dr. Ghate and Dr. Acharya) voted for pause. Surprisingly, the most hawkish MPC member Dr. Michael Patra voted for rate cut. However, his statements in the MPC minutes indicate that he probably voted for cut reluctantly. This time, given the sequential increase in inflation and rising food and fuel prices, Dr. Patra could vote for pause splitting the MPC equally between pause and cut. In such a case, Governor’s veto power would be crucial. We expect the stance of monetary policy to remain ‘neutral’.
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