The Reserve Bank of India (RBI) headquarters in New Delhi. (Photographer: Anindito Mukherjee/Bloomberg)

Are We Set Up For A Prolonged Pause In Rates?

The Monetary Policy Committee’s decision to keep interest rates unchanged on Thursday was no surprise. But it’s decision to cut its inflation projections for the new financial year was. That decision has changed the economic narrative (at least temporarily) to one where interest rate hikes seem less likely over the course of the current financial year. This, despite the fact that one of the six members of the MPC has voted for a rate hike for two consecutive quarters.

The MPC expects Consumer Price Index inflation in the first half of the financial year at 4.7-5.1 percent. For the second half of the year, it projects inflation at 4.4 percent. Excluding the impact of house rent allowance revisions (which are seen as largely statistical), CPI inflation is projected at 4.4-4.7 percent in the first half of 2018-19 and 4.4 percent in the second half, said the MPC.

Importantly, the inflation projection put for 2019-20 also suggests that price pressures will remain in check despite an expected pick-up in growth. The monetary policy report, written by the RBI’s internal staff, said that inflation is expected at close to 4.5-4.6 percent in the next financial year.

If that is so, the MPC, which is mandated with keeping inflation in a 4 (+/-2 percent) band, may see little reason to hike rates.

“The downward revision to inflation forecasts is a positive surprise and suggests no imminent policy tightening. For now, the RBI remains in wait-and-see mode,” said Sonal Varma, chief India economist at Nomura in a note following the policy review.

Economists that BloombergQuint spoke with said that a change in rates is unlikely at least over the next few months, but cautioned that the picture could change in the second half of the year.

“I can see why the RBI has marked down its forecasts for the first half of the year. Where I was a little surprised was the cut in forecast for the second half of the year,” said Sajjid Chinoy, chief India economist at JPMorgan. Chinoy noted that there is greater clarity on the upside risks from increase in minimum support prices now and should have been factored into the inflation forecast for the second half of the year. Also the strong recovery on growth being projected by the RBI could add to inflation pressures, Chinoy said.

The combination of those factors - minimum support price, oil and higher growth made me believe that the second half inflation forecast should have been higher.
Sajjid Chinoy, Chief India Economist, JPMorgan

Saugato Bhattacharya, chief economist at Axis Bank Ltd. believes that rates will stay on hold for at least the next few policy meetings and any serious discussion on rate hikes is only likely to begin in the second half of the year. “Nothing before third quarter,” said Bhattacharya. He, too, believes that some upside risks to the second half inflation forecast may emerge.

Will rates stay on hold through the course of the financial year? You need to have data certainty before you take that call, said Bhattacharya.

One economist who has maintained a contrarian call for one last rate cut in August is Indranil Sen Gupta of DSP Merrill Lynch. He believes that inflation will surprise to the downside and leave room for one more rate cut to support growth. Chinoy does not see that possibility. Inflation would really have to surprise on the downside and consistently for the MPC to justify a rate hike, he said.

“We too are looking at an extended pause at least for 2018,” said Upasana Bhardwaj, economist at Kotak Mahindra Bank. Bhardwaj added that apart from moderate levels of inflation, the growth outlook will also warrant a pause in rates. While growth has picked up, it is still not broad based, said Bhardwaj.

The MPC expects GDP growth to revive to 7.4 percent in FY19 compared to 6.6 percent in FY18. Growth is likely to be underpinned by consumer demand, a modest pick-up in the investment cycle and a lower drag from exports.