The monetary policy committee (MPC) voted 5-1 in favour of leaving the policy repo rate unchanged at 6.25%, in line with both consensus and our expectations. However, the RBI cut the statutory liquidity ratio (SLR) to 20% from 20.5% from June in order to provide banks with greater flexibility to meet the higher liquidity coverage ratio (LCR) of 100% (currently 80%), which will come into effect from January 2019. The RBI stated that despite inflation moderating sharply in April, the MPC decided to leave policy rate unchanged because a “premature action at this stage risks disruptive policy reversals later and the loss of credibility”. In the press conference, the RBI stated that the current moderation of inflation was a reflection of a combination of factors (demonetisation, supply glut etc.) that are very difficult to disentangle at this stage; thus, the MPC needs to ‘unravel’ these factors before taking action.
The RBI sharply lowered its inflation projections for H1 FY18 (year ending March 2018) to 2-3.5% (from 4.5% earlier) and H2 FY18 to 3.5-4.5% (from 5%), with risks evenly balanced. It also lowered its FY18 GVA growth projection marginally to 7.3% from its 7.4% projection made during the April policy meeting (vs 6.6% in FY17).
It maintained its neutral policy stance, stating that it would “remain watchful of incoming data” as it needs to assess “whether or not the unusually low momentum in the reading for April will endure”. During the media conference, the RBI stated that it would “see through” the inflation prints for the next couple of months before taking any action.
Headline CPI inflation is expected to remain low in the near term on low food prices due to improved supply (pulses and vegetables) and on lower core inflation due to the still-lingering disinflationary effects of demonetisation and the negative output gap. We currently expect RBI to leave rates unchanged through March 2018, which would then be followed by a cumulative 50-bps rate hikes starting April 2018.
The author is MD & chief India economist at Nomura