RBI may hold repo rate yet again; govt’s fiscal math, liquidity to remain in focus

By Upasna Bhardwaj

The growth-inflation dynamics continue to be favourable towards MPC (Monetary Policy Committee) preferring to remain on pause for a prolonged period. Inflation readings over the past few months have been undershooting RBI’s estimates by over 50 basis points.

The MPC in its last policy had estimated inflation at 3.9-4.5% in 2HFY19. We estimate inflation at 2.9-4.3% in 2HFY19 as food inflation continues to remain benign, especially as most Kharif crop prices remain well below the MSP prices.

While the food inflation is expected to keep headline inflation muted, there remains significant divergence with the core inflation. However, core inflation should also ease off eventually given the cyclical slowdown. Recent GDP print and lead indicators also seem to be suggesting further moderation in economic activity in the quarters ahead.

External concerns too seem to have ebbed as reflected in the gains in the rupee on the backdrop of falling crude oil prices, FPI inflows and easing trade war concerns as US-China attempt to work out an amicable deal. The dollar strength seems to have fatigued as Fed speakers voice out concerns on global outlook ruling out chances of more than 50bps rate hikes in 2019.

The freefall in crude oil prices has provided the much-needed relief to the Indian financial markets. However, the sustainability of the slide still remains to be ascertained given the high probability of supply cut announcement later this week.

Besides, the reason behind the fall in crude oil prices-either excess supply or weaker global growth- also will determine the risk sentiments going ahead. But for now, there seems to be some relief rally, which is providing the MPC some comfort.

Two fronts to watch out for

While things may have stabilised lately, we remain watchful on two fronts. First is the uncertainty on fiscal consolidation even as the government continues to reiterate its intention of adhering to the targets. The GST collections have not been very encouraging with the monthly run-rate suggesting a revenue shortfall of Rs 1.5 trillion.

Even if the changes are made to the GST Act in the winter session allowing utilisation of the surplus compensation cess fund that would still result in a shortfall of Rs 800bn (not to mention the fiscal quality that gets compromised).

Additionally, expenditure compulsions further may stress on public finances. Already, FYTD fiscal deficit for the centre has reached 104% of BE compared to 96% in the corresponding period last year.

The second important aspect that continues to dominate the market is the primary liquidity requirement. We expect liquidity conditions to remain tight in the rest of FY2019 on the back of continued currency in circulation leakage and build-up of cash balance amid calibrated government spending to adhere to fiscal targets. To ease overall liquidity and to compensate for the aggressive FX intervention in 1HFY19, RBI has been rightly so continuing OMO purchases.

While we do not expect any significant liquidity related measures in the policy, RBI is expected to continue to take adequate measures during the course of the year through OMO purchases and FX intervention. Additionally, we do not rule out further increase in FALLCR leeway, an extension of FALLCR dispensation for NBFC lending until March 31, 2019, from the current deadline of December 31.

We believe that the RBI will be comfortable with the overall liquidity deficit of around Rs 1.2 trillion ((-)1% of NDTL). We estimate systemic liquidity deficit at around Rs 1.9 trillion for March 2019 after additional OMO purchases of Rs 1.2 trillion in the rest of FY2019. Besides, we yet do not see the need of using CRR to infuse liquidity.

Our assessment indicates that liquidity is strained only in pockets and is not a system-wide crisis. Given that CRR is currently at reasonably low levels, we believe that the use of CRR should be restricted to special times (like as incremental CRR requirement during demonetization) rather than as a regular tool for liquidity management.

A CRR cut will have a multiplier-led impact on credit over the next few quarters. Given that structural liquidity deficit (beyond (-) 1% of NDTL) is unlikely to sustain into FY2020, we see a limited need for CRR cut.

Keeping in view the above arguments, we reiterate our call that the RBI will likely pause for the rest of FY2019 but the stress on being watchful on upside risks to inflation emanating from various indicators. While 3QFY19 inflation estimates may undergo downward revision, RBI may want to keep 1QFY20 estimates of 4.8% intact on the conservative side.

Besides, the recent extension of the GDP time series and a reasonable downward revision of the backdated series pose an important question on whether India’s potential GDP would also be lower. It will be interesting to see how RBI perceives the future inflation trajectory, especially given MPC’s reiteration in the previous policy statements that ‘output gap has virtually closed’.

(Upasna Bhardwaj is vice president and economist at Kotak Mahindra Bank Ltd. The views are the author’s own)