Is a neutral monetary policy stance a bad thing?
Markets were taken by surprise when the RBI (Reserve Bank of India) changed its monetary policy stance to neutral from accommodative in its February 2017 meeting.
But should they be worried?
This change in stance may actually be good. It may indicate that the central bank is confident about economic activity and does not need as much support from monetary policy as it did earlier. Though an argument can be made about the effectiveness of monetary policy being the reason for the neutral policy stance, the central bank’s views on economic growth lean towards the former argument.
The RBI expects India’s GVA (gross value added) growth to be 6.9% for the financial year 2016-17. This is lower than 7.1% projected earlier, but importantly, it sees risk as evenly balanced.
For the next financial year 2017-18, the central bank expects GVA growth to be sharply higher at 7.4% due to an increase in consumer demand. It also sees support from the government’s commitment on increasing capital expenditure and focus on rural India in the Union Budget for 2017-18 to help spur economic activity.
Risks to India
But a far bigger risk is posed by the United States. The risks are twofold:
- Changes in trade and immigration policy by the Trump administration
- The pace of rate hikes in the US
Blanket goods taxes like the proposed border adjustment tax will hurt India’s exports while reduction in H1B visas and outsourcing jobs will negatively impact Indian information technology companies like Infosys (INFY) and Wipro (WIT), in addition to impacting service exports.
The rate hike aspect seems more manageable as its predictability is higher than that of the former. However, it can stall a rate cut in India because cutting rates at a time when the US is increasing would mean speedier outflows as compared to India leaving rates unchanged.
If the first risk does not turn out to be as big as is being feared, then investors interested in investing in India (INDA) (EPI) could be in for a strong performance by Indian equities due to well-placed macroeconomic fundamentals as compared to other emerging markets.
Speaking of the performance of Indian equities, let’s look at how they responded to the monetary policy announcement in February and what can you expect going forward, in the next article.