RBI monetary policy review: Status quo likely with a cautious stance
An RBI rate hike is unlikely until the August meeting. Beyond that, the rate action would be heavily dependent on how the upside risks to inflation materialize
As we approach the new financial year and the first monetary policy committee meeting of 2018-19, the markets are keenly awaiting the likely forward actions by the committee across all spectrums. On the rates front, we continue to remain watchful on the inflation and economic activity indicators to determine the Reserve Bank of India’s (RBI’s) deliverables in the months ahead.
Consumer Price Index (CPI) inflation is on an expected upward path as adverse base effect and seasonally high food prices begin to push CPI inflation higher in the coming months. RBI, in the previous policy, had stated that they expect CPI inflation to peak around 5.6% in 1QFY2019 before moderating towards ~4.5% by March 2019. While our own estimates suggest retail inflation is inching towards 5.6% by June 2018 and would moderate thereafter, we are wary on the several upside risks to the expected downward trajectory.
These risks will be emanating from monsoon, implementation of states’ house rent allowance, uncertainty on commodity prices, fiscal slippages at a consolidated level and adverse expenditure quality and higher minimum support price (MSP) for kharif crops. There remains uncertainty with regard to the definition of the costs and crops for the MSP hike by 1.5x, which should keep RBI nervous.
Further, domestic growth has surprised on the upside, with the real gross domestic product (GDP) accelerating to 7.2% in 3QFY18, compared with 6.3% in 2QFY18. Even the high frequency data, especially related to manufacturing, has been promising. However, recent inflation readings have surprised on the downside and, globally, commodity prices have broadly remained unchanged since the last policy. Also, the US Federal Open Market Committee (FOMC), under the new chair, has signalled policy continuation.
All in all, forward guidance of the monetary policy committee (MPC) is expected to remain unchanged from the last policy. While maintaining a cautious stance, MPC would prefer to wait for clarity on the above-mentioned risks and then evaluate the possibility of a stance change and/or a rate hike. We maintain MPC is expected to keep rates on hold, even though the risk of an extra MPC member voting for a rate hike (beyond RBI executive director Michael Patra) cannot be completely ruled out.
Notably, even as MPC has remained on hold in past six months, financial market conditions have started to tighten in the past few months. The commercial paper/certificate of deposit rates have hardened by 30-70 basis points (bps), term deposit rates have also risen 40-50 bps in the past three months which is now gradually seeping into higher lending rates. As economic recovery still remains at a nascent stage, we believe MPC may still want to remain extremely watchful before an action. We thus see limited scope of any rate hike action until the August meeting. Beyond that, the rate action would be heavily dependent on how the upside risks to inflation materialize.
Beyond rate calls, markets are keenly awaiting RBI’s decision on the foreign portfolio investment (FPI) debt limit enhancement. Expectations are that FPI limits could be increased to 7% of outstanding debt in the next 2-3 years from the current limit of 5%. However, it will be interesting to see the categories for which the increase would take place. Unless the increase in FPI debt limit happens for the general category, the euphoria could be limited. Anyways, any such increase in FPI debt limit will be probably offset by reduction in statutory liquidity ratio/held to maturity (SLR/HTM) limits, which is also due for review in the coming policy.
Upasna Bhardwaj is senior economist at Kotak Mahindra Bank Ltd.
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