RBI monetary policy: Status quo with caution in April and during 2018
The upside risk to inflation trajectory that gathered pace during the early winter months has subsided subsequently, reinforcing a status quo in the repo rate during 2018
The Reserve Bank of India’s (RBI’s) monetary policy committee (MPC) looks set to leave the repo rate unchanged in April, likely with a neutral monetary policy stance. Since the last MPC meeting in February, Consumer Price Index (CPI) inflation has softened by about 80 basis points (bps) to 4.4%. We expect CPI inflation to average a benign 4.6% during 2018-19. The upside risk to inflation trajectory that gathered pace during the early winter months has subsided subsequently, reinforcing our view of a status quo in the repo rate during 2018.
Admittedly, CPI inflation will likely rise over the next 3-4 months to average 4.9% during the first half of 2018-19. However, the likely elevated CPI trajectory in the first half of 2018-19 would primarily be a reflection of statistical factors (e.g. the rise in house rent allowance, or HRA, and adverse base effects) rather than rising inflationary pressures.
CPI inflation will likely peak at 5.5% in H1 2018-19, a tad lower than the upper end of the RBI’s forecast band of 5.1-5.6% for this period. More importantly, CPI inflation is expected to soften significantly during the second half of 2018-19, averaging 4.2%, reflecting continued effective management of food inflation by the government, likely softer oil prices, easing of the HRA effect and base effects. Our forecast contrasts notably with the upside risks flagged by the RBI to its H2 2018-19 CPI projection of 4.5-4.6%.
At the February meeting, for the first time an MPC member voted for a hike as the debate within the MPC shifted to “hold vs hike” (from “hold vs cut” earlier). The tone of the MPC meeting minutes was more hawkish than expected. Nevertheless, the MPC does not seem to be in a rush to hike the repo rate in the coming months.
The policy remains data dependent; the likely softening in CPI in H2 2018-19 should prompt the MPC to stay on hold, especially as policymakers seem mindful of not stifling the recovery in growth at its current nascent stage.
In this context, the ongoing uptick in gross domestic product (GDP) growth needs careful interpretation. While recovery is visible across a number of sectors, year-on-year growth prints are currently exaggerated owing to a notably low base. Even if headline year-on-year GDP growth stays above its recent trend rate during 2018, this should not be seen as a sign of overheating, given persistent low manufacturing capacity utilization (71-74%), weak private capital expenditure and real GDP growth average of sub-7% in recent years. In sum, the current uptick in GDP prints will likely not pose a risk of triggering monetary tightening during 2018.
In terms of the upside risks to our projected CPI inflation trajectory, potential weather uncertainties are well recognized. The Australian Bureau of Meteorology (BoM) recently indicated the start of a “neutral” El Niño-Southern Oscillation (ENSO) phase in March 2018 from La Niña conditions that prevailed since December 2017. The Indian Meteorological Department (IMD) is scheduled to publish its first set of forecasts for the 2018 monsoon season in April.
Second, crude oil price trend remains a key risk even though we expect softer oil prices during H2 2018.
Third, one remains watchful of signs of populism, if any, in the coming months. Finally, the current account deficit (CAD) continues to widen and will likely reach 2.1% of GDP in 2018-19; the MPC might turn more cautious on the monetary policy front if the current account gap widens further beyond such levels. Nevertheless, despite taking all such risks into consideration, on balance, unchanged policy rates during 2018 remain our baseline forecast.
Siddhartha Sanyal is the chief economist - India at Barclays Bank PLC. Views expressed herein are personal.