Notably, the Reserve Bank of India (RBI) revised up the inflation range (albeit marginally), by 10 bps to 4.3-4.7%, even as they tried to downplay the upside risks (high commodity prices, firm core inflation and fiscal slippage) to the trajectory by mitigating factors like seasonal fall in vegetable prices, and goods and services tax (GST) rates.
The tone of the policy statement in itself seems to suggest a prolonged pause (probably through FY19) even as inflation and growth follow an upward path.
However, going into FY2019, we expect the inflation trajectory to be clouded with adverse base effect and seasonally high food prices, along with pickup in core inflation on the back of higher demand.
The economy is expected to recover in the subsequent quarters as GST-related disruptions smoothen out and as consumption improves amidst rising rural wages, lower GST tax incidence and expected payouts from State’s implementation of the 7th Central Pay Commission.
Under these circumstances, we see upside risk to core inflation.
Also, the policy highlighted that “implementation of farm loan waivers by select states, partial roll back of excise duty and value-added tax in the case of petroleum products, and decrease in revenue on account of reduction in GST rates for several goods and services may result in fiscal slippage with attendant implications for inflation."
Undoubtedly, the noise around a likely fiscal slippage has surmounted the uncertainties. Notably, the fiscal deficit until October had already hit 96.1% of the budgeted figures, given the heavy front-loading of government spending and slower pace of revenue collections.
Teething issues with GST implementation (such as delays in tax credits and tax filing along with technological issues) and lower rates is clouding the tax collections scenario.
Lower surplus transfer by the central bank to the tune of around Rs30,000 crore has further increased the risks of revenue slippages.
Additional shortfall of Rs30,000-35,000 crore from excise duty cuts on petroleum products and spectrum proceeds could, overall, create a gap of nearly Rs1 trillion.
While higher divestments and special dividend proceeds may partly offset the shortfall, risks still remain high.
Meanwhile, markets were awaiting clarity on the central bank’s stance on liquidity conditions.
RBI, in the post policy conference, suggested that liquidity seems comfortable, with the weighted average call rate trading at 12 bps and 15 bps below the repo rate during October and November, as against 13 bps in September.
Further, they noted that the open market operations (OMO) between July-November were to drain the liquidity infused from the foreign flows in the early part of the year.
RBI expects liquidity to remain marginally in surplus before moving towards their long-held target of neutral zone by mid FY2019. However, our estimates suggest we could drift towards neutrality in the next quarter itself.
We also note RBI’s net long forward book outstanding as on October 2017 is near the highest ever at $32 billion. Almost 50% of this is due for maturity this year. Liquidity surplus and the subsequent decision of OMO sales will then be a function of RBI’s choice to the extent of delivery of the forward outstanding.
Overall, while this policy seems to be broadly balanced, we continue to focus on the underlying trends in inflation given the MPC’s mandate to anchor inflation around 4%.
With upside risks emanating from fiscal slippage, higher oil prices, higher real wages, sticky core inflation and mean reversion of food prices, we find limited room for any further monetary accommodation. Even as inflation trends higher, MPC may prefer to still maintain a status quo through FY19 given that a sufficiently high real rate provides them adequate headroom to absorb higher inflation.
The writer is senior economist, Kotak Mahindra Bank.