For the second monetary policy meeting in succession, the Reserve Bank of India chose to maintain status quo on policy rates in-line with consensus expectations. As such, markets metrics (bond yields, currency) have changed a little after today’s decision. Unusually-persistent uncertainties on several fronts have truncated RBI’s degrees of freedom since the last repo rate cut in August. Even as there is increasing comfort on the global growth recovery and the emergence of green shoots in domestic economic activity post demonetisation and GST-related disruption, the RBI has chosen to wait and watch. This is because: First, crude oil prices continue to firm-up, as the India crude basket now trading 32% higher vis-à-vis its June-2017 low. This is likely to convolute the growth-inflation mix, as it could posit a downside to growth, but an upside to inflation.
As per the November RBI survey, inflation expectations of households have inched higher, amid higher food and fuel prices. In general, commodity prices have been rising and a return of producer pricing power could soon pose upward pressure on retail prices. However, persistence of excess capacity and downward adjustment in certain GST rates for certain items could dilute the pass through impact of higher input prices. In terms of the future outlook for crude prices, while there is general consensus that they may remain largely subdued, geopolitical risks and OPEC-Russia’s rare consensus on production cut-back has the potential to put a spanner in the wheel. Second, core CPI inflation is likely to show a sustained up move in the coming months. This is likely to be a culmination of several factors including the central and state HRA payouts, of which the former is expected to peak this month as per the RBI. On a net basis, our in-house estimates suggest that RBI’s measure of core CPI could move in the range of 4.5-5.6% in the next two quarters, maintaining a positive gap with headline CPI, which we project to be in the range of 4.5-5.0%. However, one should note that a large part of the firming up of core inflation would be led by statistical impact of HRA adjustments, some of which could get potentially offset by downward adjustment in GST rates for few items. Last and not the least, today’s RBI meeting was the last before the presentation of the FY19 Union Budget. The RBI is justifiably cautious of the unfavourable impact of state farm loan waivers, partial roll-back of excise duty and VAT of petroleum products and the November GST rate reduction on the fiscal deficit. December would be crucial month as clarity emerges on the trend in GST tax revenues, netting for input tax credit, even as these readings may not yet be fully comparable to FY17 due to a different tax regime altogether.
In the interim, as the haze lifts over the next few months, the government has been provided fair chance to play the lead batsman. While growth is expected to gain from favourable statistical base-effects as well as the pickup in momentum post-GST, the central bank has recognised the positive externalities to growth from the bank recapitalisation plan, the improvement in Ease of Doing Business ranking and the Insolvency and Bankruptcy Code. In the upcoming budget, the government gets renewed chance to work on investment/consumption multipliers by focusing on the infrastructure and rural sector. In the recent months, government bond yields have begun to factor-in interest rate increases. However, historically, the RBI has had a tendency to provide atleast three-four quarters of cooling-off period before it considers a rate move higher. Going forward, I would expect the RBI to remain on the sidelines, as it assesses the mix of positive and negative factors. On a more favourable note, factors in favour of a future repo rate cut could be government restraint on FY18 and FY19 budget, lower-than-expected CPI prints and/or delays in global monetary policy normalisation.