With recent inflation readings coming in much softer than expected, the MPC is likely to hold policy rates for now.
In its forthcoming policy review on December 5, 2018, Reserve Bank of India (RBI) would hold rates in our view. The backdrop this time is much more benign than at the time of the October policy review when INR was falling sharply and crude oil was on a boil. This stoked concerns about inflation, driving RBI to change its policy stance to ‘calibrated tightening’ from ‘neutral’ even though it left the rates unchanged.
The situation has changed materially since then: firstly, inflation has been softer than expected and will likely undershoot the RBI’s projections and, secondly, crude oil prices have cooled off 30%. This not only improves inflation outlook, but notably eases the stress on the balance of payments (BoP) and rupee.
In light of this, a rate hike is unwarranted in our view. Indeed, the improved backdrop gives the RBI ample room to ramp up open market purchases to inject durable liquidity in the economy. On balance, we believe the December policy review is likely to be a non-event with no change in policy rates.
Soft inflation provides a favourable backdrop
In the last policy review, the Monetary Policy Committee (MPC) had marked down its H2FY19 CPI forecast by 60bps to 4.2%, largely because of lower food inflation. Inflation for the month of October 2018 came in at 3.3%, the lowest since September 2017. Food CPI was flat, primarily because of deflation in pulses and vegetables. Inflation rates of other food items (cereals, milk, meat, spices, etc) are also quite low (2–3%). Given the emphasis the MPC lays on inflation readings, the continued softness in inflation (undershooting its projected trajectory) does not warrant any policy action at this stage.
Other factors (domestic and global) are supportive, too
With a 30% slide in crude oil prices since the last policy review, concerns around the current account deficit as well as BoP have broadly eased. Rupee has reversed course and has strengthened meaningfully. And with the rupee stable/ strengthening, RBI gets enough wiggle room to address liquidity tightness through FX purchases or open market operations (OMOs). Very recently, the RBI announced additional OMOs of Rs 40,000 crore for December to inject durable liquidity in the economy.
Our view: Pause for now
Inflation outlook is the predominant guiding force for the MPC. With recent inflation readings coming in much softer than expected, the MPC is likely to
hold policy rates for now. Any tinkering with the cash reserve ratio is also not likely as the RBI has been regularly conducting open market purchases. Meanwhile, the MPC is likely to retain its policy stance—‘calibrated tightening’. All in all, the forthcoming policy review is likely to be a non-event.
Edited extracts from
Edelweiss report – RBI Policy Preview