RBI, Onions and Monetary Policy

The outcome of RBI’s sixth and final bimonthly monetary policy statement for the FY 2019-20 is unsurprising. Repo has been retained at 5.15% and therefore the other rates like MSF, reverse repo, bank rate etc. too remain unchanged. RBI projects a growth of 6% something in alignment with what the budget has projected. They anticipate higher uncertainty in inflation. The question however, is given the macroeconomic dynamics at the current instant, could RBI stance been bolder or was it cautious reiteration of its mandate.

As one delves in to the RBI monetary policy statement (available here) some interesting pointers emerge. Global headwinds continue to impact the Indian economy too. There is no respite for European economies like France and Italy on the continued downward growth trend. Britain will have to confront with post Brexit uncertainties. US Iran tensions may have eased down momentarily but the impact might take a time to ease out, US-China trade wars demonstrate ebbs and tides creating ambiguity. The emergence of coronavirus in China has virtually led to a shutdown in industrial, manufacturing, retail and services activity in large parts of China. There is no consensus yet among the experts on the likely impact of viral epidemic on the economic activity both in China and abroad. Therefore, given the global headwinds and the possible protraction of the same into the instantaneous future, Indian economy would have been well served by a booster dose.

In RBI’s own valuation, domestic economy apparently is on the cusp of a turnaround. Clarity, however, eludes on the durability or otherwise of the turnaround. Undeniably, Nov and Dec 2019 saw continued contraction of production and import of capital goods. Investment therefore is expected to remain sluggish for some more time.  The current growth needed a counter-cyclical measure which is invariably comes from increase in revenue expenditure of the government. The budget estimates and revised estimates confirm the same.

Yet the agricultural activity seems to be picking up. Despite some shortfall on kharif, rabi has shown an increase. With normal to above normal south-east monsoon rainfall, reservoirs are around 70% of total storage up from around 45% last year. Barring onions, food production seems to be normal. India’s trend in movement towards horticultural production seems undisputed. Onion prices rising are resulting in upward movement of nearly three times of the food inflation. A detailed analysis on food inflation and the solutions is discussed here. Excluding onion prices, food inflation would have been down by 4.7% points. So onions have virtually skewed the food inflation basket which skews the headline CPI basket. Implied is a monetary policy centred on inflation targeting held hostage by one single vegetable-onion! The outcome is therefore reduced to addressing imbalances in onion supply-demand dynamics rather than overall assessment of the directions of economic growth and activity.

Capacity utilization which was dipping continuously into Q2 2019-20 might see a reversal in fortunes. Core industries are in the black after a couple of quarters of red. PMI is hitting a seven year high in manufacturing in Jan 2020. Similarly services PMI too experiences eight year high in Jan 2020. Therefore they good lead indicators of what portends for the economy in the near future. One must be cautious in reading and interpreting these lead indicators. They are mere pointers and not conclusive objects of economic growth. Both rail freight traffic and port activity manifest acceleration though motorcycle sales, a good indicator for rural and semi-urban activity still shows signs of contraction. Air traffic continues to increase thanks to expansion of UDAN.

In RBI’s assessment, headline inflation would have remained in 4-5% zone but for onion prices. Core CPI and core WPI both continue to remain weak though fuel inflation seems to show some positive signs. Fuel inflation remains low and was in negative for some time despite political tensions in the Persian Gulf. Fuel prices are unlikely to pick up given the anticipated economic slack in China. Core CPI too rose only because of the rise in mobile phone charges and transportation charges. Given the stickiness in these prices, there is unlikely to be an upward movement for months of Jan or Feb 2020. The core inflation might unsurprisingly fall a bit in the last quarter of FY 2019-20.

Household inflation expectations have eased, the business confidence levels have increased, while non-essential household expenditure continues to decrease, overall consumption spending is likely to exhibit an uptick. RBI foresees surplus liquidity conditions. Interestingly demand for loanable funds seems to lag being the supply of loanable funds despite southward direction of effective interest rates. RBI suggests 87 bps reduction in vehicle loan rates and around 40 bps reduction in housing loans measured as Weighted Average Lending Rate (WALR). RBI feels there is a sizeable monetary transmission across various money market segments and private corporate bond market.

FDI continues to increase, however, a point of concern persists over a continual decline in exports accompanied by a slump in imports too. Gold imports have declined. There is small shift in momentum towards assembly of consumer electronics and durables in India, a sort of boost for Make in India. RBI anticipates softening of the food inflation despite a couple of adverse conditions in milk and kharif crops segments. They anticipate some volatility in oil prices, a bit of greater uncertainty injected thanks to China coronavirus. RBI points towards a rising input prices yet competitive nature of the industry coupled with weak demand conditions might result in firms absorbing these increments in input costs. They presume a rise in consumer spending following the changes in the income tax rates in the Union Budget. This might be optimistic given there are certain uncertainties in the slabs and clarity might be while coming on the income tax slab and exemption front.

The output gaps continues to be in negative zone. Despite high frequency indicators pointing towards positive signals, RBI feels caution is advised over the sustenance of the indicators. What perhaps the economy needs is strong signal from the government and RBI over their intentions to clear the pathways for rekindling of animal spirits. The budget was disappointing the in macro-signals it was supposed to send.  RBI too could have been bold and gone with at least a symbolic cut of 15bps bringing the repo to 5%. At the very least it could have sent a signal of detachment of onion economics from the rest of economic activity. Perceptibly while RBI’s decision seems a visible relief in not hiking the rates yet apparently an opportunity missed given the projected turnaround to reduce the rates. This one single act would have imparted fresh animal spirits rekindling the northward direction in the Indian economy.