By- Sonal Varma & Neha Saraf
The Reserve bank of India’s (RBI) Monetary Policy Committee (MPC) voted 5-1 in favour of leaving the policy repo rate unchanged at 6.00%, in line with consensus and our expectations.
Despite acknowledging weaker growth, the RBI stayed pat due to a 2 percentage point (pp) rise in inflation since August’s policy meeting, heightened financial market volatility due to global developments (Fed balance sheet unwinding and a risk of policy normalisation by the ECB), higher oil prices and potential inflationary pressures from fiscal slippage.
The RBI projects inflation (including the central house rent allowance) to rise from current levels to 4.2-4.6% in H2 FY18 (year ending March 2018), which is marginally higher than the projection made at the August policy meeting (of ~4.5% by Q1 2018).
The RBI acknowledged the possibility of slowing growth (widening output gap) but nevertheless maintained its neutral policy stance, stating that it “requires more data to better ascertain the transient versus sustained headwinds in the recent growth prints”.
The central bank’s decision to maintain the status quo is indicative of its inclination to look through the near-term outlook, which is clouded by transitory factors and concerns over higher core inflation. Overall, the policy appears neutral.
In our view, growth has bottomed out and we expect a recovery, led by ongoing progress following remonetisation, restocking efforts following the implementation of the GST and the lagged effects of lower lending rates. We also expect inflation to rise above 4% in coming quarters, as we expect the output gap to gradually narrow, as well as on statistical and transitory factors such as the house rent allowance increases and the lagged pass-through from the GST tax changes. We also see a higher probability that the central government will miss its budgeted fiscal deficit target of 3.2% of GDP in FY18 by 0.3pp.
Against this backdrop, we expect the RBI to leave policy rates unchanged in our base case. Weaker-than-expected growth, an undershooting of the 4% inflation target and the government sticking to its budgeted fiscal consolidation target could open up room for more accommodation, in our view.
The writers are economists at Nomura