After the back-to-back tightening in the previous two policies, the Monetary Policy Committee (MPC) had presciently voted 5:1 to retain the policy repo rate at 6.5% in the October 2018 policy review. At the same time, it had changed the stance of monetary policy from neutral to calibrated tightening, also by a vote of 5:1.
With the subsequent correction in crude oil prices and the strengthening of the `, and with market prices for various crops remaining below the revised minimum support prices (MSPs), the repo rate appears unlikely to be changed in the remainder of FY19.
In October 2018, the MPC had revised its CPI inflation projections downwards for Q2FY19 (to 4% from 4.6%), H2FY19 (to 3.9-4.5% from 4.8%) and Q1FY20 (to 4.8% from 5.0%), while describing the balance of risks as being somewhat to the upside. Moreover, it had retained its GDP growth projection for FY19 at 7.4%, with risks broadly balanced.
Subsequently, the y-o-y CPI inflation corrected sharply to a 13-month low of 3.3% in October 2018, from 3.7% in September 2018, printing below the MPC’s medium-term target of 4% for the third consecutive month. The correction in the headline CPI inflation print in October 2018 was led by the y-o-y disinflation in food prices. In contrast, the core-CPI inflation rose to an uncomfortably high 6.1% in October 2018.
Two-way volatility in crude oil prices and the $-` cross rate has dominated discussions of Indian macro fundamentals in FY19. Following exemptions from US sanctions on Iran for India and seven other jurisdictions, and concerns regarding over-supply, the price of the Indian crude oil basket has moderated from as high as $85/barrel in October 2018 to around $60/barrel at present, tempering the risks to the Indian inflation trajectory. Moreover, after persistent weakening since the beginning of FY19, the ` has recovered by around 5% from the all-time low recorded in October 2018.
Following the correction in the October 2018 CPI inflation, and the pullback in crude oil prices and the `, the MPC is likely to maintain a status quo on the repo rate in the December 2018 policy review, in our view. Although the CPI inflation in Q3FY19 is likely to lag the MPC’s estimate, an immediate rate cut is ruled out given the recent change in stance to calibrated tightening and the high core-CPI inflation print for October 2018.
Looking ahead, the outlook for food inflation remains mixed. Market prices of various crops remain substantially lower than the revised MSPs. An uneven and sub-par monsoon, flooding in some areas amid a late withdrawal of the monsoon rains, and instances of crop damage and pest attacks are likely to weigh upon kharif output of some crops, which may emerge as a risk for food prices. Moreover, the weak trends in post-monsoon rainfall and rabi sowing may create price pressures over the next few quarters.
Fiscal factors such as the staggered pay revision by some state governments and expenditure announcements by the central and various state governments may also add to inflationary pressures.
Going forward, geopolitical developments and supply-demand balances would affect crude oil prices, and consequently the sentiment toward the ` and the inflation outlook. At present, our base case does not factor in a sharp rebound in crude oil prices or a re-testing of the all-time low by the `. Overall, there appears to be a muted likelihood of a rate hike in the February 2019 policy review as well, in ICRA’s view.
The deficit in post-monsoon rainfall and lagging rabi sowing also pose a concern for the outlook for agricultural growth and rural sentiment. Moreover, the prevailing disinflation in food prices has cast concerns on the sustainability of the strength of rural demand in the near term. Commentary by various corporates related to their Q2 FY2019 earnings suggests that urban consumption sentiment is mixed. While the staggered pay revision by state governments and GST rate cuts would support urban consumption demand, higher fuel prices on a y-o-y basis may constrain the improvement in the purchasing power of consumers.
The fiscal space for spending by the government of India in FY19 is contingent on several revenue and expenditure risks, such as the likelihood of meeting the targets for the GST, dividends and profits, and disinvestment, and the adequacy of outlays for revised MSPs and subsidies. Additionally, ICRA has observed a trend of expenditure announcements from various state governments over the recent months. Overall, we expect some cutback in capital spending to offset higher-than-budgeted revenue expenditure, which would support consumption growth at the cost of infrastructure spending in FY19.
Notwithstanding RBI’s recent decision to defer the scheduled increase in Capital Conservation Buffer for FY19 by one year, most public-sector banks (PSBs) still face capital constraints, which would limit their ability to drive credit growth. Meanwhile, private banks are constrained by their ability to attract incremental deposits, as the deposit franchise of the PSBs largely remains intact. The extent to which access to credit improves for the MSME sector would have an impact on business sentiment and economic growth in FY19.
Given the risks posed by the y-o-y rise in commodity prices, the availability and cost of financing for various sectors, the depreciation in the `, and the threat of trade wars, ICRA expects a shallow recovery in the GDP growth to 7.2% in FY19 from 6.7% in FY18.