There was no surprise from the Reserve Bank of India, which kept all key policy rates unchanged.
The central bank characterised its policy stance as accommodating, which we interpret to be a reaffirmation of the neutral liquidity goal outlined in the April policy statement. In explaining its decision, RBI painted the picture of an economy on the mend and facing some upside risk of inflation.
While we see neither the growth pick-up nor the inflation outlook as dramatic, the balance of risk needs to be seen in the context of a central bank trying to keep inflation around 5%. With that goal in mind, the RBI’s policy room is limited, in our view.
The central bank retained the inflation projection given in the April policy statement, but it highlighted upside risks to the forecast. Already, April inflation outturn was higher than anticipated. With commodities prices recovering somewhat more in May, we reckon there was no easing of inflation last month either.
Potential inflationary impact of seventh pay commission awards (timing and magnitude is still unclear), the upturn in inflation expectations of households and corporates, and sticky core CPI inflation were seen as additional risks.
A good summer monsoon and various supply management measures were, however, seen as some mitigating factors which could offset some of the upside risks, but even then RBI felt that there were rising uncertainties surrounding the baseline inflation projection.
RBI kept its FY17 GVA growth forecast unchanged at 7.6% y-o-y (FY16 GVA growth as 7.2% y-o-y), noting that domestic conditions of growth are improving gradually, supported by consumption demand and public capital expenditure, which ought to crowd in private investment, thereby partially offsetting the subdued appetite for fresh private investment due to financial stress.
The statement flagged some uptick in earnings among the non-financial companies, strong core infrastructure production, rise in consumer sentiment, increasing capacity utilisation, and possible support from rural demand on the back of likely normal monsoon. Indeed, the description of growth conditions in the statement was quite upbeat, in our view.