With CPI inflation close to the upper end of Reserve Bank of India’s (RBI) inflation tolerance band of 6%, the policy status quo was largely anticipated. However, as a mark of continuity, RBI reiterated its accommodative stance in spite of the acknowledgement of upside risks to its March 17 inflation target of 5%. This is consistent with anticipated comfort on the inflation trajectory in the near term. In addition, the gradual impact of structural reforms on economic activity and the new Monetary Policy Committee (MPC) will remain the support ‘variables’ in RBI’s rate easing equation.
On inflation, the upside risks enumerated by the RBI are genuine but the role of factors disrupting the policy trajectory are expected to be limited at best, as:
*With the government choosing to defer the implementation of allowances under the 7th CPC, any near term spillover pressure on inflation is unlikely to play out
*Prudent administrative steps in rationalisation of procurement prices will moderate the structural pressure on secondary market food prices
*Improvement in water levels on the back of a pickup in monsoon is likely to have a salubrious impact on rabi sowing season later in the year
In addition, the government’s resolve towards maintaining stable price conditions remains unhinged. The introduction of supply management measures along with structural reforms such as the GST, the Bankruptcy Code stand to strengthen potential growth while keeping a lid on inflation. This along with the strong monsoon outturn will help to reverse the recent seasonal upside pressures recorded in food items.
As such, average CPI inflation is expected to come around 5.1% in FY17 vis-à-vis 4.9% in FY16 with Mar-17 inflation expected to be a tad below the 5% level. This will allow RBI to opt for a 25 bps cut in the repo rate in Q3 FY17. Having said so, RBI will nevertheless need to continue to guide inflation expectations lower in the economy.
Going forward, with the Government having notified the adoption of the inflation target framework of 4% with a band of +/-2% over the next five years, the next monetary policy will likely witness the institutionalization of the MPC, officially formalising the inflation targeting framework. In the post policy interaction, the RBI Governor did indicate adequate flexibility with regards to the notified target, defining the current band as broad enough and inflation surpassing the top-end of 6% being a realistic scenario (i.e failure to achieve the target), albeit on a non-sustainable basis.
In addition, the efforts to maintain comfortable money market liquidity conditions in line with the new liquidity framework to eliminate structural liquidity deficits in a calibrated manner are likely to continue to aid monetary transmission (the RBI announced liquidity infusion via OMO purchase in today’s policy).
Over the last two years, RBI’s efforts to restore macroeconomic stability have been accompanied by Government’s sincere resolution of structural growth impediments. The next policy review in October, with a new Governor and a new MPC in place (the latter adding to policy continuity and credibility), will mark the onset a new phase of monetary decision making in India.
(The author is chief economist at YES Bank)