RBI’s MPC votes for a non-unanimous rate cut, in line with expectations
In an eagerly awaited policy announcement, the six-member Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) decided to cut the repo rate by 25 basis points (bps) in the Third Policy Review for FY2018, while retaining the neutral stance of monetary policy. The rate cut followed from the recent sharper-than-expected fall in inflation, the MPC’s assessment that certain upside inflation risks have either eased or not materialized, and consequently, the downward revision in their baseline trajectory for inflation going forward.
In line with our expectation of a non-unanimous rate cut, the vote to reduce the repo rate to 6.0% from 6.25% was taken by a margin of 4-2. Interestingly, one member voted for an even larger reduction of 50 bps, while the other dissenting member favoured a status quo. From the close consensus displayed in their early meetings, the MPC members’ views regarding the extent of inflation risks have become more nuanced over the last year, and the minutes of this meeting will be carefully parsed for clues regarding the future outlook for Indian monetary policy.
In the June 2017 policy review, the MPC had sharply revised its forecast for the CPI inflation for H1 FY2018 to 2.0-3.5% (from an average of 4.5%) as well as for H2 FY2018 to 3.5-4.5% (from an average of 5.0%). It now expects the trajectory (excluding the impact of the revision in house rent allowance or HRA) to be lower than its June 2017 projection, forecasting a print of ‘a little above 4%’ by Q4 FY2018. Nevertheless, the MPC continues to expect the CPI inflation trajectory to record a rise in H2 FY2018 relative to H1 FY2018. Key inflation risks highlighted by the committee include the impact of the revision of HRA on housing inflation, price revisions that were deferred prior to the transition to the goods and services tax (GST), and potential fiscal slippages at the state government level following the implementation of crop loan waivers by some states. Based on the expected rise in inflation in H2 FY2018, the MPC retained a neutral policy stance. Moreover, it indicated it would continue to observe incoming data and reiterated its commitment to keep inflation close to 4% on a durable basis.
At the current level of the repo rate, we don’t expect the monetary policy stance to be revised to accommodative from neutral, unless the baseline inflation projection for 6-12 months ahead eases below 4.0% in a durable manner. Moreover, there appears to be a low likelihood of further rate cuts in FY2018, unless the CPI inflation appreciably undershoots the MPC’s revised projection. Although the progress of the monsoon and kharif sowing has been reasonably favourable so far, the recent spike in prices of some vegetables is likely to push the CPI inflation to 2.5% in July 2017 from the series-low 1.5% in June 2017, in our view. Moreover, ICRA expects the impending reversal of the favourable base effect to push inflation above 4.0% by October 2017.
The minimal reaction displayed by the 10 year Government security yield highlights that today’s rate cut had already been priced in by the market, as well as the subdued likelihood of further monetary easing by the RBI in FY2018.
In terms of the real sector, the Committee highlighted that although the outlook for agriculture appears bright, the momentum appears to be weakening for industry and services. In particular, industrial growth has eased in April-May 2017, as measured by the Index of Industrial Production (IIP). On balance, the MPC retained its GVA growth forecast for FY2018 at 7.3%, while expressing concern regarding the risks related to the stress in the balance sheets of various banks and corporations. Additionally, it highlighted the urgent need to reinvigorate private investment, remove infrastructure bottlenecks and boost affordable housing.
ICRA expects the GVA growth to print at 7.0% in FY2018, somewhat lower than the MPC’s expectation. However, we caution that high frequency indicators for June-July 2017, such as the soon-to-be-released IIP for June 2017 (ICRA expects a 1.0% contraction) and the sub-50 PMI reading for July 2017—are likely to be inordinately influenced by the short-term impact of the transition to GST, and therefore should not be construed as a cause of alarm. Systemic liquidity remains in surplus, with the upfronting of expenditure by the government partly offsetting the rise in currency in circulation and the associated dip in bank deposits. In our view, the RBI would continue to conduct open market operations (OMO) to mop up excess liquidity. In addition to the Rs300 billion of OMO sales announced by the RBI over the last two months, ICRA expects further OMO sales of Rs200-300 billion in multiple tranches.
Aditi Nayar is principal economist at Icra Ltd.