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Monetary Policy: Having Hiked Rates As Expected, MPC Now Set For A Pause


In the run-up to the August Monetary Policy Committee meeting, the market consensus was clearly in favour of a rate hike. We had expected the MPC to deliver a rate hike in August and maintain its neutral stance. The Reserve Bank of India’s MPC, after its surprise unanimous decision to hike the repo rate in June, delivered a 5-1 verdict in August in favour of a rate hike, maintaining the neutral stance. Subsequent to the front-loading of two successive rate hikes in June and August, against the backdrop of only a nascent stage of recovery in growth momentum, and likely softening in headline Consumer Price Index inflation prints during the second half of 2018, we maintain that the MPC is set for a prolonged pause.

We expect the next rate hike to take place in April-June 2019. 

August Statement Flags Two-Way Risks For CPI Trajectory

The August policy communication brought some interesting developments. In a break from previous policies, the outlook for inflation has been tempered with both upside and downside risks (as opposed to the oft-found dominance of upside risks flagged by the MPC in the recent past). For instance, the oil price related risk was flagged as a key two-way risk. Yesterday’s statement also stressed on considerable uncertainty as regards inflationary consequences of the proposed hike in the minimum support price of summer crops; the statement suggests that clarity in this regard will emerge over “next several months” – likely suggesting a lower likelihood of another move in rates in near term, in our view.

Importantly, during the post-policy interactions, RBI Governor Urjit Patel emphasised on the headline CPI inflation, stressing on its status as the legal mandate for the MPC.

Enhancing the MPC’s emphasis on headline inflation should, in our view, have a dovish implication in the near term given the likely softening in headline inflation over the next about six monthly prints.

The RBI acknowledged that actual inflation outcomes have undershot its projections, and lowered the Q2FY19 estimates marginally. However, it is interesting to note that the subsequent projection for the second half of the year were broadly left unchanged, citing the prevailing uncertainties.

In a welcome development, the RBI published its projections for Q1FY20 CPI inflation (projected at 5 percent year-on-year). The monetary authority, perhaps to signal its nimbleness, seems to have adopted a rolling 12-month horizon for the publication of its inflation projections, doing away with the prior practice of sticking to fiscal year-end estimates. In this context, since the RBI had viewed the risks to its CPI projections as evenly balanced, its subsequent reaction as data gets revealed needs to be carefully watched, especially in case of intensification of risks of CPI moving higher during 2019 vis-a-vis the MPC’s current forecasts.

Also read: India Snatches the Punch Bowl, Just in Time

“Other” Indicators Helped MPC Go Ahead With August Hike

On the growth front, MPC reposted its faith in the sustainability of the economic recovery, noting the closure of the output gap. However, in a revealing statement in the press conference subsequent to the policy, Governor Patel expressed his comfort with growth rates in the range of 7 percent to 7.5 percent. Separately, the MPC felt that the rising trade protectionism is likely to pose a “grave risk” to global growth as it hampers productivity and global supply chains.

Apart from the various inflation indicators, the MPC will likely have continued to look into a number of macroeconomic and financial market-related indicators as well (like, oil prices, the Rupee, foreign portfolio investor flows, monsoon trends). For instance, since the June MPC meeting, FPI flows into Indian debt and equity markets worsened further and the rupee continued to weaken, while the decline in crude oil prices has been modest. In general, fund flows into emerging markets have slowed considerably in recent months, with both equity and bond funds experiencing outflows. Overall, these factors likely prompted the MPC to front-load further monetary tightening and deliver another repo rate hike in August.

Softer CPI Patch, Nascent Growth Recovery To Prompt RBI To Stay On Hold

According to our estimates, headline CPI inflation will likely soften during the second half of 2018, despite only a gradual softening in core inflation.

Headline CPI surprised to the downside in June and we continue to expect the June print to, by-and-large mark the near-term peak in CPI inflation.

We expect year-on-year prints to largely soften during the second half of 2018, reflecting in part a markedly favorable base and likely averaging 4.6 percent year-on-year during FY19 (H1: 4.8 percent, H2: 4.5 percent). This is despite the intensification of a number of risks – an uptick in services inflation in the second quarter of 2018, higher oil prices, a weaker Rupee, large increases in MSP for agricultural products, a sub-optimal monsoon and weak sowing of summer crops.

However, these risks prompt us to turn more watchful of inflation risks over the 6-12 month horizon. Food inflation has been remarkably subdued recently (past 18-month average is 2.4 percent) and acted as a strong buffer for overall CPI.

We expect food inflation to move higher than its recent trough, but to stay largely anchored, well below its long-term average of 7-8 percent.

On balance, we expect the MPC to stay on hold in the near term. Given the benign trajectory for headline CPI inflation we expect in the second half of 2018 and the early stage of the recovery in growth, we expect the RBI’s repo rate hikes to be calibrated rather than aggressive in the coming months. Our baseline expectation is that of one more hike of 25 basis points in the repo rate till mid-2019, likely in the second quarter of 2019. We expect the MPC’s action to remain data dependent, likely with a continued bias for caution. However, despite the RBI’s inflation target mandate, we expect policymakers to stay mindful of not stifling growth recovery at its current nascent stage.

Siddhartha Sanyal is Director and Chief Economist - India, at Barclays Bank.

The views expressed here are those of the author’s and do not necessarily represent the views of BloombergQuint or its editorial team.