India’s ‘Dovish’ RBI Faces Stubborn Inflation: Decision Guide

The Reserve Bank of India’s new set of growth-focused policy makers will need to grapple with stubbornly high inflation in their first meeting this week, preventing them from cutting interest rates.

The Monetary Policy Committee is set to maintain the benchmark repurchase rate at 4% Friday, according to all 24 economists surveyed by Bloomberg. The government appointed three new external members to the six-person MPC this week, academics who have favored monetary and fiscal stimulus in the past to fire up the economy.

While Governor Shaktikanta Das has led the previous MPC in cutting rates by 115 basis points this year, he’s taken a more cautious approach recently as consumer prices spiked. Das is keen to preserve policy space in case economic growth prospects sour further as India becomes a global hotspot for the coronavirus pandemic.

“The upcoming policy will be a damp squib on conventional policy action front,” said Madhavi Arora, economist at Edelweiss Securities Ltd. in Mumbai. The new MPC members will likely provide a more dovish tilt to policy over time and allow the committee to continue its accommodative stance, she said.

The rate decision was originally scheduled for Oct. 1, but was pushed back after the government delayed appointing the new members in time. The posts have been filled by Ashima Goyal, Jayanth Varma and Shashanka Bhide.

Here is what to watch out for in the MPC statement:

Growth Outlook

The central bank will publish growth forecasts for the current fiscal year, providing the first official estimate of an economy that’s being hit harder than most major nations in this pandemic. Gross domestic product shrunk by a record 23.9% in the June quarter from a year ago, and economists surveyed by Bloomberg predict an 8% contraction for the year through March 2021.

Latest high-frequency indicators show activity is stabilizing as lockdowns to stem the pandemic are lifted, though the risk of a surge in virus cases across the country remains a risk.

Inflation Forecast

The RBI’s consumer price projections will be closely watched given that inflation is sitting well above the 4% midpoint of the bank’s 2%-6% target band. Economists surveyed by Bloomberg are forecasting inflation of 5.5% in the year to March.

While food prices may ease and a stronger rupee could help curb import costs, local supply chains are yet to be restored following one of the strictest lockdowns in the world.

Unconventional Tools

Policy makers could turn to more unconventional steps like open market bond purchases and the RBI’s own version of yield curve control to keep borrowing costs in check and ensure better transmission of policy rate cuts to the banking system.

That’s an important goal for the RBI, since it also manages the government’s bond sales. The government is planning record borrowing this year as revenue slumps, and with states also likely to rack up additional debt, India could see its combined fiscal deficit surge to more than 10% of GDP.

“We expect the RBI to remain active with a host of unconventional measures which will likely include more proactive bond purchases to ensure that market interest rates do not rise significantly higher due to fiscal and market borrowing related concerns,” said Kaushik Das, India chief economist at Deutsche Bank AG in Mumbai.

— With assistance by Tomoko Sato

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