Policy Day Guide: No Rate Move But Could Communication Change?
The MPC may not change rates, but a change in policy stance is being closely watched.
The Monetary Policy Committee (MPC) will announce its final policy review of the current fiscal today, amidst concerns of upside risks to inflation and a surge in bond yields.
Higher consumer price inflation over the last few months has eliminated room for further interest rate cuts. All but one of the 33 economists in a Bloomberg survey predict the benchmark repurchase rate will remain unchanged at 6 percent -- its lowest since 2010 -- with Rabobank International the only one calling for a 25 basis-point hike.
Economists, however, will be closely watching the MPC’s language to gauge whether an extended pause in the interest rate cycle is likely or if rate hikes will begin as soon as 2018.
The Inflation Picture
India's consumer price inflation rose to a fresh 17-month high in December on the back of higher vegetable and crude oil prices coupled with an unfavourable base effect. At 5.2 percent, it inched closer to the upper end of the MPC's inflation target of 4(+/- 2 percent). The RBI’s professional forecasters’ survey expects inflation to cool to 4.4 percent by March-end and then pick up again to 4.9 percent by June-end.
Inflation risks are overdone as the vegetable price spike has started reversing said BofA Merrill Lynch Global Research in a note. The brokerage house expects the MPC to persist with its slightly hawkish pause despite this, it said. The MPC should look through the coming jump in inflation, growth and credit growth over the next few months as the year-on-year increase is driven by base effects, it added.
Not everyone agrees.
Rising oil prices, and the higher minimum support prices for kharif crops announced in the union budget may push inflation up and have "increased the probability of higher rates in 2018-19", said Abheek Barua, chief economist at HDFC Bank in an emailed statement. Household inflation expectations, something that the MPC watches closely, are also ticking up again, pointed Axis Bank in a report. The inflation trajectory may move up over the next 5-6 months, it added.
Global Commodity Price Risk
Another key factor remains global commodity prices.
"The recent upturn in crude oil prices has emerged as a source of concern," RBI governor Urjit Patel had said during the previous policy review. Even deputy governor Acharya flagged off the oil prices risk saying that it "poses difficult domestic policy challenges". The significant input cost pressures in the economy, may, at some stage, get passed on to retail prices, Acharya said.
Since the MPC last met, global commodity prices have risen further. The Bloomberg Commodity Index, which constitutes of 22 commodities across the globe, has gone up 5.1 percent over this period. Higher commodity prices "pose a risk" to the fiscal position and inflation, Axis Bank said.
In particular, crude oil prices have gone up nearly 10 percent since the December policy review. It is going to be “very, very crucial” to see for how long high oil prices sustain, said Upasna Bhardwaj, senior economist at Kotak Mahindra Bank Ltd. said.
Higher Fiscal Deficit
Finance Minister Arun Jaitley confirmed in his budget speech that India has slipped from its fiscal consolidation path. It expects its fiscal deficit at 3.5 percent of the gross domestic product in 2017-18, as opposed to the 3.2 percent that was being targeted. In 2018-19, the government is targeting a fiscal deficit of 3.3 percent. This would be brought down to 3 percent only by financial year 2020-21.
It must be noted though that the deficit has come from a shortfall in the government’s revenue rather than excess spending. The lower revenue has been on the account of the implementation of the Goods and Services Tax. The Centre will receive only 11 months of GST revenue this year, as the March collections would come in April.
Since the fiscal slippage is due to a revenue shortfall, the inflationary fallout may be limited, said Bhardwaj.
Still, the MPC will take note of the fiscal situation.
A fiscal slippage has "attendant implications" for inflation, the MPC had noted in its December review. In its October policy, the RBI had estimated that a 100 basis point increase in fiscal deficit could lead to a permanent increase of about 50 basis points in inflation. This was calculated using the combined fiscal deficit of states and Centre which was budgeted at 5.9 percent of the GDP in 2017-18.
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Higher Bond Yields
The bond markets will be closely eyeing the RBI's stance on liquidity. Bond yields have risen since the MPC last met. The 10-year government bond yield is up by another 50 basis points since the time of the December policy review and is now at 7.568 percent. Global bond yields have also risen in recent weeks.
Interest rates in the domestic bond market have reacted to concerns of tightening liquidity conditions and higher government borrowings, along with fears of rising inflation.
But Bofa-ML Global Research thinks that even these concerns are overblown as the RBI has stepped up durable liquidity injection to $27 billion from barely $4 billion at the end of November last year. "Still, markets will look to the RBI policy on Wednesday for confidence building measures," it said in the research note.
The RBI, on its part, may not only focus on bond market rates. It will also look at the inter-bank markets, where interest rates are stable and close to the current repo rate set by the central bank. This suggests there is no significant liquidity shortage at a systemic level.
