What to expect from the RBI Monetary Policy in April?

Despite the apparent case for a rate cut, RBI may look at it as a toss-up and may adopt the waiting game.

Apr 01, 2019 12:04 IST India Infoline News Service

The RBI monetary policy announced in February was brave in two ways. Firstly, it cut the repo rates by 25bps when the trajectory of the Fed was not yet clear. Secondly, the MPC also changed the stance of the monetary policy from hawkish to neutral, opening the doors for further rate cuts. The chart captures monthly CPI and IIP for the last one year.
 
Data Source: MOSPI

Over the last one year, retail inflation and IIP growth have trended down. Inflation fell sharply due to a steep fall in food inflation and fuel inflation, even as core inflation stayed around 5.3%. IIP growth trended down through the year due to weak manufacturing growth, which accounts for over 70% of IIP.
 
Inflation and growth make a case for a rate cut
This will be the last data point on inflation and growth ahead of the April 04th MPC meeting. Of course, there will be the core sector numbers for February, which will give an approximate indication. The RBI had set a worst case limit of 4% for CPI inflation and, for now, the retail inflation appears to be well within the limits. Of course, Goldman Sachs has projected food inflation to more than double to 2% in the next fiscal but that is still some time away to really worry about. In the last two policies, the MPC members have made it clear that they have a preference for pushing growth over containing inflation. Also, the RBI has clearly shifted its focus towards headline inflation from core inflation. On paper, both these variables make a case for a rate cut. But will the RBI bite the bullet?
 
Fed outlook adds impetus to rate cut demands
Post the Fed meet outcome on 20th March, there seems to be a strong demand from the industry bodies for an aggressive rate cut. Normally, the RBI also considers the risk to capital inflows in the event of a rate cut. FPI flows into bonds are a function of the benchmark 10-year yield differential between the US and India. With the US bond yields falling to below 2.5%; the spread now stands at around 500 basis points. With the rupee largely stable, that should give the RBI room to cut rates. Also, the Fed has almost ruled out rate hikes in 2019, so any US yield spike looks unlikely for now.
 
Will the RBI cut rates in the April policy?
Second guessing, the central bank’s action is never an easy task. Despite the apparent case for a rate cut, RBI may look at it as a toss-up and may adopt the waiting game. There are 3 reasons why the RBI may be in two minds about a rate cut in April.
  1. The rate cuts in the February policy hardly led to worthwhile transmission to the end user. That is something the RBI has not been too happy with, since weak transmission defeats the very purpose of a rate cut.
  2. With the global economy veering towards a slowdown, it is uncertain how much of an impact a rate cut at this point will make to growth. If growth is the intention, then the timing of the rate cut may not be the opposite.
  3. For real cues, look at the Dollar Swap auction. The RBI has hinted greater focus on infusing liquidity as a monetary strategy than on rates. If the RBI does more dollar swaps then yields may automatically come down due to liquidity.
 
RBI has choices other than a rate cut in April. For the final decision, we have to wait till April 04th.

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