India’s Monetary Policy Committee today kept interest rates unchanged and maintained a neutral stance, even as it raised its inflation forecasts and reiterated a commitment to maintaining the headline inflation at close to 4 percent.
The MPC, however, highlighted a number of upside risks to inflation, suggesting that a rate hike in the next financial year is now a real possibility. Five of the six MPC members voted for a status quo on rates. Michael Patra, executive director at the Reserve Bank of India, voted in favour of a 25-basis-point hike.
- Following the review, the benchmark repo rate remains at 6 percent.
- The reverse repo rate will be held at 5.75 percent.
The decision was in line with market expectations. All but one of the 33 economists polled by Bloomberg News expected a status quo on rates.
MPC On Inflation
The MPC said it expects consumer inflation to average 5.1 percent in the final quarter of 2017-18. For the next financial year, it expects the inflation to range 5.1-5.6 percent in the first half, declining to 4.5-4.6 percent in the second. Over the medium term, the MPC is tasked with maintaining inflation in a band of 4 (+/- 2) percent. It reiterated this commitment today.
The committee highlighted six upside risks to inflation:
- The staggered impact of HRA increases.
- Higher commodity prices due to strong global growth.
- Revised guidelines for minimum support prices of kharif crops.
- An increase in customs duty on a number of items.
- Impact of fiscal slippage on inflation.
- Normalisation of global monetary policy.
“….There is, therefore, need for vigilance around the evolving inflation scenario in the coming months,” the MPC concluded.
It also highlighted the mitigating factors for inflation.
First, capacity utilisation remains subdued. Second, oil prices have moved both ways in the recent period and can potentially soften from current levels based on production response. Third, rural real wage growth is moderate.MPC Statement
MPC On Fiscal Pressure
The MPC took a hard line on the government’s fiscal stance and its decision to delay the fiscal consolidation process.
….fiscal slippage as indicated in the Union Budget could impinge on the inflation outlook. Apart from the direct impact on inflation, fiscal slippage has broader macro-financial implications, notably on economy-wide costs of borrowing which have already started to rise. This may feed into inflation.MPC Statement
While announcing the annual Union Budget on Feb. 1, the government said the fiscal deficit for 2017-18 would settle at 3.5 percent. This is higher than the targeted 3.2 percent. For 2018-19, the government is targeting a fiscal deficit of 3.3 percent and gross borrowings of Rs 6 lakh crore.
The wider-than-expected fiscal deficit target and concerns over high borrowings have led to a rise in bond market yields.
MPC On Growth
Growth, meanwhile, is recovering as expected.
According to the MPC, GVA growth of 6.6 percent is expected this year. Next fiscal year, growth is expected to rise to 7.2 percent. According to the MPC, there are early signs of revival in investment activity as reflected in the pick-up in credit growth. Stability in the GST framework, the recapitalisation of public sector banks and the insolvency proceedings underway in large cases are also expected to aid growth.
The Economic Survey presented ahead of the Budget pegged growth for 2017-18 at 6.75 percent – in line with the RBI’s estimate. The full-year growth forecast suggests a pick-up in the third and fourth quarters of 2017-18.
The Committee is of the view that the nascent recovery needs to be carefully nurtured and growth put on a sustainably higher path through conducive and stable macro-financial management.Monetary Policy Committee Statement
RBI On Liquidity
Commenting on prevailing liquidity conditions, the RBI signaled that it will not intervene to cool down yields in the bond markets.
The objective of the liquidity operations conducted by the RBI are not to manage the price of any long-term assets, but to meet the liquidity needs of the economy in line with the stated stance of monetary policy, Deputy Governor Viral Acharya, said during the press conference after the central bank’s monetary policy meeting.
Except in rare, extraordinary, economy wide circumstances, the goal of RBI’s liquidity operations is not to manage directly the prices of any particular long term asset market.Viral Acharya, Deputy Governor, RBI
How Markets & Experts Reacted
Bond yields fell following the policy announcement. The benchmark 10-year bond yield closed at 7.53 percent compared to yesterday’s close of 7.57 percent.
Economists noted that the policy stance was not as hawkish as some had feared.
"The monetary policy was, in our opinion, far less hawkish than expectations, implying that unless things go really awry (particularly in oil markets or the domestic fisc) and push inflation way above the projected trajectory, the RBI could stay on hold,” said Abheek Barua, chief economist at HDFC Bank in an emailed statement. Barua added that there could be some decline in bond yields in the near term.
Sonal Varma of Nomura said that the MPC is “comfortably” on hold for now.
“The statements suggest that while the RBI is growing more confident on the growth recovery,its inflationary concerns are also rising. However, it is waiting for more clarity on the costing details of the new MSP mechanism to ascertain the impact on inflation,” Varma wrote in her report.
Watch BloombergQuint’s coverage of the monetary policy committee’s decision here.
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