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As expected, the Reserve Bank of India (RBI) MPC kept the policy repo rate unchanged at 6 percent in the April 4-5, 2018 meeting. Given that this was the first meeting of FY19, the RBI’s estimated inflation trajectory forms the nub of the policy.
The Monetary Policy Report (published biannually) outlined that the inflation trajectory would hover around the 4.5 percent mark, not just in FY19 but in FY20, too.
With headline CPI inflation expected to be in a ‘no-man’s land’ for an extended period and growth seeing some nascent recovery, the RBI is likely to remain on an extended wait-and-watch mode.
While the policy should provide some cheer to the bond market, further downward move in yields will be contingent on the fiscal situation and sustained lower inflation prints.
The RBI revised its inflation forecast lower to 4.7-5.1 percent (earlier estimate of 5.1-5.6 percent) for 1HFY19 and 4.4 percent (earlier 4.5-4.6 percent) for 2HFY19.
However, the RBI remains wary of the adverse impact on inflation from
(1) a revised formula for MSP for Kharif crops,
(2) staggered impact of HRA revisions by state governments, specifically second-rounds impact,
(3) further fiscal slippage either in FY19 or in the medium-term path,
(4) adverse temporal or spatial distribution of monsoons,
(5) surveys indicating that input and output prices could rise going forward, and
(6) recent volatility with hardening bias in crude prices.
The MPC noted that growth has been recovering and the output gap is closing. There has been some recovery (especially in the investment cycle) as indicated by the recent pickup in credit offtake, sustained growth in capital goods production and higher non-oil imports.
However, caution should be exercised as global growth could swiftly move lower on the back of rising trade protectionism and volatile global financial markets. We estimate FY19 GDP growth at 7.3 percent, in line with RBI’s estimate of 7.4 percent.
We expect headline inflation to trend towards 5.2 percent by June 2018 partly led by unfavorable base effect, before moderating towards 4.5 percent by end-FY2019. This trajectory would neither provide comfort to the RBI (being above 4 percent on a sustained basis) nor convincingly warrant a rate-hike cycle (not significantly higher than 4 percent).
We remain cautious on the core inflation part, which could stay high as the economy undergoes a gradual cyclical recovery and corporates possibly gain pricing power through the year.
We expect headline and core inflation to average 4.6 percent and 4.9 percent in FY19 (3.6 percent and 4.5 percent in FY18). As highlighted above, there are various upside risks to the inflation trajectory. A nascent cyclical growth recovery is underway.
The RBI will take cognizance of this dynamics. Also, a change in stance would be warranted when a series of rate actions seems necessary rather than a token rate action.
In the current scenario, the conditions necessitate a wait-and-watch policy with a hawkish bias. However, any sharp deviation from the RBI’s estimated inflation trajectory on account of non-transitory causes may prompt the RBI to revisit its neutral stance.