RBI’s monetary policy committee should stay in pause mode
The minutes of the February policy meeting of the Reserve Bank of India’s (RBI’s) monetary policy committee (MPC) revealed that most members had viewed the evolution of headline CPI inflation to be a cause for concern, with most risks to inflation being on the upside. While only one member voted for a hike in the repo rate, my own reading was that there could have been a few more votes in the same direction if there had not been some consideration for nurturing the nascent economic recovery.
When RBI met for the last policy decision, the retail inflation print for January was higher than 5% and RBI had estimated the January-March 2018 inflation to be at 5.1%. Further, RBI estimates for headline CPI inflation was at 5.1-5.6% for the first half of 2018-19 and easing to 4.5-4.6% by the second half of 2018-19.
However, the evolving scenario on inflation has altered a bit with continuing softness in vegetable and pulses prices. Headline CPI inflation was down to 4.4% in February and estimates show that it can dip further to around 4-4.1% in March. These levels are definitely lower than the 5.1% that was being estimated by RBI for January-March 2018.
Further, even as base effects will take headline retail inflation higher to around 4.7-4.8% by June, the risks of inflation being in a range of 5.1-5.6% levels in the first half has definitely reduced significantly.
Average headline CPI inflation for FY19 is now being estimated by us at around 4% levels, around 40-50 basis points (bps) higher than the average for FY18. Consequently, MPC members can breathe relatively easy when they meet next in April and some of the hawkish tilt that was seen during the previous meeting could get reduced.
Thus, bets for RBI to raise rates during the year have nearly vanished for now. However, this does not, on the contrary, open up too much space for RBI to reduce the repo rate either. The MPC, in February, had noted that there were some upside risks to inflation emerging from higher crude oil prices, India’s fiscal slippage in FY18 and also a possible slippage in FY19, staggered implementation of HRA increase by state governments, and the uncertainties related to the new provisions announced in the budget for MSP increases. And let us also not forget that even as headline CPI inflation had been witnessing some downward bias, the same is not quite true for core inflation. With growth trajectory stabilizing, the expectation could be for core inflation to remain sticky at around the 5% mark.
Thus, RBI is likely to maintain a hawk’s eye on the evolving inflation trajectory. The further context for RBI would be the unfolding scenario from the global monetary space. With risks rising for a tighter monetary policy globally, the chances for RBI to bring down rates, even as headline retail inflation stabilizes at a near-4% level would remain minimal. My base case would thus be to see RBI continue to remain in pause mode for an extended period—possibly through the whole of FY19.
As RBI gets ready for the first policy meeting of a new financial year, the bigger role carved out for the central bank in FY19 could be on the liquidity front rather than on the rates front. The currency in circulation has once again shot up to levels seen in the days just ahead of the demonetization exercise in November 2016.
Further, with oil prices sticking at higher levels, we see risks for the CAD/GDP ratio to move higher to around 2.4% in FY19, with the consequent impact of a possibility of driving BoP or balance of payments into negative territory. Thus, the risks in FY19 towards maintaining adequate liquidity to drive economic growth can be more relevant. In this context, it would be difficult to totally rule out RBI resorting to OMO or open market operations security sales during the year.
10-year yield had gapped down to close at 7.33% on the day immediately after the government announced a much easier-than-expected borrowing programme for the first half of the year. In the event that RBI engages in OMO sales during the year, the 10-year yield could inch back to levels higher than 7.50% once again.
Indranil Pan is group chief economist at IDFC Bank Ltd.
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