Dr. Urjit Patel and team surprised the markets today in the Fourth Bi-monthly Monetary Policy Statement, 2018-19, by maintaining status quo in the policy rate as against an expected rise of 25 bps. However, the monetary policy stance changed from neutral to calibrated tightening, and this is in line with their objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent, while supporting growth.
RBI's Views on Inflation and Growth
The Monetary Policy Committee (MPC) has actually gone out and reduced the projection for CPI to 4.0 per cent in Q2:2018-19, 3.9-4.5 per cent in H2 and 4.8 per cent in Q1:2019-20, with upside risk potential. These numbers are definitely lower than those given in the Monetary Policy Review held in August 2018, wherein CPI was projected at 4.6 per cent in Q2:2018-19, 4.8 per cent in H2 and 5.0 per cent in Q1:2019-20, with risks evenly balanced.
The central bank cited the following factors as the bases for this projection: (1) inflation remained benign and is expected to be in the downward trajectory in the second half of the year also; the first advance estimates placed production of major kharif crops for 2018-19 higher than last year’s record which mitigates the risk to inflation from spatially and temporally uneven rainfall; these projections also take into account the increase in Minimum Support Prices (MSPs) announced in July; (2) the price of oil has increased by US $ 13 a barrel since the last resolution; (3) international financial markets remained volatile with EME currencies depreciating; and finally, (4) the House Rent Allowance (HRA) effect due to increased allowance for central government employees came off its peak in June and is decreasing gradually.
Although RBI is positive on factors like improving capacity utilisation, larger FDI inflows and increased financial resources for the corporate sector, which can increase the investment activity in the economy, it also highlights risks like the tightening in the global and domestic financial conditions, and the rise in oil prices and other input costs that can hamper such investment. The RBI feels that the outlook for exports remain uncertain. In their own words: “Tailwinds from the recent depreciation of the rupee could be muted by the slowing down of global trade and the escalating tariff war.” Considering all these factors, GDP growth projection for 2018-19 is retained at 7.4 per cent as in the August resolution (7.4 per cent in Q2 and 7.1-7.3 per cent in H2), with risks broadly balanced; the path in the August resolution was 7.5 per cent in Q2:2018-19 and 7.3-7.4 per cent in H2. GDP growth for Q1:2019-20 is now projected marginally lower at 7.4 per cent as against 7.5 per cent in the August resolution.
Although the tone of the policy is not as hawkish as always, the RBI continues to believe that there are upside risks to inflation like: (1) measures announced by the Government to remunerate the farmers for their produce, (2) uncertainty in oil prices on account of supply disruptions caused by geopolitical tensions, (3) volatility in global financial markets, (4) rise in input costs along with rising pricing power, which in turn can lead to rise in prices of both goods and services, (5) the fiscal slippage at the centre, and (6) the staggered impact of HRA revision at the centre or state levels.
The central bank has come out with a dovish policy statement, which was not expected by the market participants in the current scenario wherein oil prices and currency are posing risks to the macroeconomic environment. However, our view is that although the rates have been left untouched this time, the fact that the policy stance has changed from ‘neutral’ to ‘calibrated tightening’, is a clear indication from the RBI that the way forward is either a status quo or a rate increase from here on.
In our India market outlook 2018 released in January, our advice to our Fixed Income investors was the following: “We are of the belief that the RBI will either maintain status quo or increase rates if oil prices or currency decide to play spoilsport in 2018. Investors across risk profiles can continue to take an exposure into ultra short term funds or short term funds, while our moderately aggressive and aggressive investors can explore dynamic bond funds.”
RBI’s change in policy stance today validates our views on interest rates and we maintain status quo on our recommendation to our Fixed Income investors. The change in the stance today clearly means that easing of monetary policy is out of the question, at least for now.