RBI’s money policy: Should a monetary expansion follow fiscal expansion?


The growth-inflation dynamics continues to point towards a dovish policy tilt in the RBI’s policy review tomorrow. However, the recent expansionary Budget has pulled back chances of monetary easing in the near term.

On the inflation front, the outturns have been undershooting MPC’s downward revised inflation range of 2.7-3.2 per cent in H2 of FY19 by around 40bps. Oil prices have broadly remained unchanged compared with levels seen around the December policy. Core inflation remains sticky with recent unexplained spikes in certain components like rural health and education and hence remains cause for worry. Muted food inflation and weak global commodity prices however, continued to ease the headline price pressures.

Since the last policy, domestic and global economic outlook has further deteriorated. Domestic high frequency indicators continue to point towards on-going cyclical slowdown led by the lagged impact of higher oil prices, weaker rupee, financial market tightness and weaker global demand. The fading private consumption growth is expected to keep the domestic growth muted in the coming quarters (the impact of rural stimulus may be seen over the medium term).

Further, a global slowdown should be a drag on export growth as well. Global economic slowdown concerns (especially in the euro zone, China and the US) have been increasingly weighing on the inflation outlook worldwide, thereby postponing/halting the monetary tightness path by the developed central banks.

For most of 2018, markets were pricing nearly two rate hikes by the Fed in 2019 and the onset of rate hike cycle by the ECB in H2 of CY19. However, markets now expect a halt to the Fed hike action (with around 20% probability of a rate cut by January 2020) along with a postponement of monetary tightening by the ECB. The consequent weaker commodity prices remain a silver lining for India.

Overall, while the growth-inflation outlook remains benign, the government’s adoption of an expansionary fiscal stance has reduced the probability of monetary accommodation in the near term. While growth is expected to remain tepid in the near term, the slowdown isn’t as pronounced so as to warrant a fiscal and monetary boost.

However, the seemingly in-part structurally benign food inflation along with softening growth should provide space for the MPC to shift the policy stance to neutral and keep the policy decisions in future data dependent.