Wednesday’s unsurprising Reserve Bank of India (RBI) decision to leave its policy rate and neutral stance unchanged while mildly raising its inflation forecast for the second half of this fiscal has put the task of spurring the economic recovery, of which there is scant evidence so far, more in the hands of a fiscally stressed government. Announcing the Monetary Policy Committee’s decision to keep the repo rate at 6% in the wake of a “sharp uptick in momentum” of retail inflation, RBI governor Urjit Patel said: “We have a neutral stance, which means that depending on the data flow (on growth/inflation) in the coming months and quarters (we) will determine…the policy.” Most analysts saw no change in the February review either, even though the MPC’s commentary was less hawkish than bond markets expected — it said risk to inflation are “evenly balanced”. The yield on the benchmark 10-year bond fell 3 basis points on Wednesday to 7.03%. For the RBI’s projection of 6.7% gross value added (GVA) growth — which it maintained in the latest bi-monthly review despite Q2 expansion coming in lower than projected in the October review — to pan out, expansion should be close to 7.6% in the second half, an assumption many analysts find a bit exaggerated. Listing out near-term factors like HRA to government staff and global oil prices that will influence inflation, the MPC said, “On the whole, inflation is estimated in the range of 4.3-4.7% in Q3 and Q4 of this year,” against an average 4.2-4.6% in the October review.
The finance ministry, which would clearly have liked a rate cut, said: “The MPC recognised that inflation remains firmly under control, retaining its inflation projection for the second half of FY 2018 and assessing that the risks to this projection are evenly balanced. For that reason, it has maintained a neutral policy stance.” Although the surplus liquidity in the system continued to decline in October-November, the MPC did not cut the cash reserve ratio either — Patel said there wasn’t any drying out of liquidity yet while deputy governor Viral Acharya saw “slightly surplus” liquidity by March. The surplus in the reverse repo markets is currently hovering above Rs 1 lakh crore and analysts don’t expect the central bank to persist with aggressive open market debt sales to drain out cash. The MPC saw a few factors that it believes augurs well for growth: An increase in capital raised from the primary market, which bucked a trend of sluggishness of the past several years; the likely enhancement of “allocative efficiency” after large stressed borrowers are referenced to insolvency resolution process and public sector banks’ recapitalisation. Stressing that public sector banks (PSBs) are offered “a reform and recap package” rather than a mere recap package that could sow the seeds of “another boom and bust cycle of lending”, Patel said the RBI was working with the department of financial services in the finance ministry to determine the amount of recapitalisation bonds to be placed on each PSB’s balance sheet and the component of external fund-raising. “Recapitalisation bonds will be front-loaded for banks that have managed their balance sheet strength more prudently and can use the injected capital to lend besides providing for legacy asset losses,” the governor said. The banks, he asserted, would receive government equity contribution based on their “resolve and progress” towards reforms in a significant and time-bound manner and become “slim and trim” by implementing better-focused strategies and selling non-core assets.
According to Patel, the MPC did not consider shifting the stance because nothing between October to December was significant in terms of the macro outcome that would warrant it. “Moderation in inflation excluding food and fuel observed in Q1 of 2017-18 has, by and large, reversed. There is a risk that this upward trajectory may continue in the near term,” he said. The central bank also cautioned that farm loan waivers by select states, partial roll-back of excise duty and value-added tax in the case of petroleum products, along with a decrease in revenue on account of reduction in goods and services tax (GST) rates for several goods and services may result in fiscal slippage with attendant implications for inflation. Following the MPC decision, rating agency Crisil maintained its inflation forecast for FY18 at an average of 4%. “… there could be room for a rate cut if the downside risks to growth materialise, and inflation undershoots the MPC’s growth forecast for the second half. The base case scenario is of MPC staying on hold this fiscal.” Sonal Varma, MD and chief economist at Nomura, said both growth and inflation are headed higher, but she expects rates to be on hold through 2018 as the RBI has a sufficient real rate cushion to absorb higher inflation. “Although there could be some downside risk to the RBI’s FY18 GVA growth projection, we believe that growth is headed higher, supported by ongoing remonetisation, resolution of GST-related issues and large bank recapitalisation,” Varma wrote. “Inflation will range between 4-4.5% for the rest of the year and hence we would rule out any rate cut this financial year,” CARE Ratings said. “Our GDP growth estimate is 6.7-6.8% which will be slightly lower than RBI implied GDP growth rate of 6.8-6.9% (given differential of 0.2% between GDP and GVA).”