SBI Ecowrap - Monetary Policy: 4-2 in favour of rate cut or an unlikely hold ?

Come 2 August , the six member Monetary Policy Committee (MPC) will announce its verdict. The good thing is that the fledgling MPC may be just settling down, with the committee members delivering a spilt verdict in June. However, there are still some thrones in the flesh as far as MPC operations are concerned.

For example, a close look at the minutes of successive MPC meetings shows that opinions have changed abruptly regarding inflation outlook. The October policy stressed on inflation target being achievable but concerns about inflation became heightened in the very next policy and have continued since then. Though in the most recent policy the members have accepted that inflation is indeed coming down, they have chosen to adopt a wait and watch stance and there are still some lingering concerns about core inflation. However, the mention of words like inflationary expectations, upside risks to inflation, firming of crude prices has come down significantly which is a good thing.

In the first minutes there was significant concern about capacity underutilization and private investment. Demonetization however side-tracked these concerns and the rhetoric since then was that output gap will start closing once remonetisation happens. But, in the last minutes again almost all the members had again raised the issue of existence of unutilized capacity in the economy.

The use of words like unutilized capacity makes us more confident of a 25 bp rate cut on 2 Aug. Additionally, there are certain developments which also increase the probability of rate cut by RBI in the coming policy. First, the progress of monsoon is quite satisfactory, as around 90% of the country (32 sub-divisions out of 36) received normal/excess rainfall till 28 July. Overall the monsoon is 4% above normal. Second, the hassle-free implementation of GST will definitely bring down inflation in the coming months as around 81% of the items are below 18% slab. Third, currently both the CPI and WPI are below-1.5% mark and we expect CPI inflation to be sub-2% for the next month, sub-3% for Aug-Sep’17 and sub-4% for Oct-Nov’17 and 4-4.5% between Dec and Mar’18. Fourth, the core inflation, on which MPC has repeatedly emphasized and given more focus, was quite stable since FY15 (though in the MPC terminology it has remained sticky) and has now slipped to sub 4%. Fifth, the pay commission allowances’ impact on inflation will be purely a statistical artefact. Our bet of the odds of a rate decision (preferably cut) this time could be 4-2.

The report has been authored by Dr. Soumya Kanti Ghosh, Group Chief Economic Adviser, SBI

Read the complete report here

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