As expected the RBI delivered a 25bps rate cut on Tuesday and stuck to its “accommodative” forward guidance. However, the RBI’s actions went further as it announced several measures to refine the liquidity management process. As outlined previously, RBI’s monetary policy over the last year had rested on three pillars — rate cuts, dovish commentary and liquidity measures — in that sequence of events and importance. Over the next year, we were expecting the relative importance of the three policy pillars to be reversed. As such, the bold liquidity measures are in line with our thinking.
Views: The RBI continues to see CPI inflation edging towards its March 2017 target of 5% with minor inter-quarter variations. The risks to this view mainly stem from weaker monsoons, low water storage levels at reservoirs, rising global commodity prices and implementation of the 7th Pay Commission hikes. Fortunately, the RBI also sees offsetting factors that can keep inflation in check, namely tepid global growth, reforms to contain food price pressures and the central government’s commitment to fiscal consolidation.
The central bank’s comfort with the inflation outlook was further evident from its projection of 4.2% CPI inflation by March 2018, which basically implies that the RBI believes it is on track to reaching the mid-point of its 4%, +/-2% inflation target by early 2018.
While we think that the 5% target by early 2017 is within reach under reasonable assumptions, reaching 4% a year later will not be a trivial task. Core inflation remains high and sticky at 5.5%, inflation expectations are near double digits, global commodity prices may not fall as dramatically as they did through 2015 and while the central government has been fiscally disciplined, states are likely to be fiscally profligate over FY17.
The RBI sees GVA growth solidifying from 7.3% in the current financial year to 7.6% in FY17 and 7.9% in FY18. This is more optimistic than our 7.4% in FY17 and 7.7% in FY18 forecast.