Monetary Policy - RBI To Remain On Hold For The Rest Of FY2017/18 - FEB 2018


BMI View : The Reserve Bank of India left its benchmark repo rate unchanged at 6.00% during its December 6 meeting, and we continue to expect interest rates to remain steady for the remainder of FY2017/18 . The central bank is constrained by opposing goals of curbing rising inflationary pressures, but also ensuring that the recent economy recovery since Q2FY2017/18 remains intact .

In line with our expectations, the Reserve Bank of India (RBI)'s Monetary Policy Committee (MPC) voted five-to-one to keep its benchmark repurchase (repo) rate unchanged at 6.00% during its December 6 meeting. In view of the recent recovery in economic growth, along with rising inflationary pressures over the coming months, we believe that the RBI is likely to continue holding interest rates steady for the remainder of FY2017/18 (April-May). As in its previous meeting, the MPC maintained a neutral stance, which is in line with its objective of achieving its medium-term inflation target of 4.0%+-2.0% while supporting economic growth. The MPC statement noted that upside risks to inflation from food and fuel prices as well as government housing allowances, are likely to be balanced by upside risks to growth from governmental stimulus measures and improved business sentiment.

Neutral Stance
India - Central Bank Decision
Source: BMI, Bloomberg

Inflation Starting To Rise

In our view, the RBI is likely to remain cautious about rising inflationary pressures, and therefore, there is little room to ease monetary policy. Headline consumer price inflation (CPI) continued to trend higher, rising to 3.6% y-o-y in October from a multi-year low of 1.5% y-o-y in June, and is likely to increase further over the coming months due to rising food and oil prices. Underlying price pressures are also rising, with core inflation (which excludes food and fuel) being on an uptrend since June, coming in at 4.6% y-o-y in October, and it is likely to face upside pressures from the increase in governmental housing allowances and rising inflation expectations by households over the coming months. Furthermore, farm loan waivers by select states, along with stimulus measures such as recapitalising public banks and increasing infrastructure investments in highways, could result in a widening fiscal deficit, presenting upside inflationary risks.

Rising Price Pressures
India - CPI Breakdown, % chg y-o-y
Source: BMI, Bloomberg

Economic Growth Just Recovering

At the same time, the RBI is unlikely to hike interest rates prematurely even as inflationary pressures rise, as the Indian economy is only starting to recover from the negative disruptions caused by demonetisation and the implementation of the goods and services tax (GST) system in July. As we have seen from the Q2FY2017/18 GDP release, real GDP growth recovered to 6.3% y-o-y in Q2FY2017/18 versus a low of 5.7% y-o-y in the previous quarter, ending the five-quarter downtrend. We expect growth to continue to recover over the rest of the fiscal year as the economy benefits from the government's optimisation of the GST system and policies to support state banks and the infrastructure sector ( see ' Growth To Trend Higher As GST Disruptions Fade ' , December 1). Manufacturing activity has recovered strongly, and is likely to continue on an uptrend due to post-festive season inventory restocking over the coming months. Indeed, manufacturing real growth surged by 7.0% y-o-y in Q2FY2017/18 from just 1.2% y-o-y in the previous quarter, while inventories expanded by 6.7% y-o-y from 1.2% over the same period.

Turning The Corner
India - Real GDP Growth By Expenditure, % chg y-o-y & Percentage Points (pp) Contribution
Source: BMI, MOSPI

A jump in gross fixed capital formation (GFCF) to 4.7% y-o-y in Q2FY2017/18 from 1.6% y-o-y in the previous quarter suggests that investment activity is on the rebound, and is likely to pick up further as the government's INR2.1trn public bank recapitalisation plan (to be implemented over the next two fiscal years), spurs credit growth. Additionally, the INR6.9trn highways expansion programme, which will take place over the next five years, will likely provide a boost to the industrial sector (including construction), which contributes to around 29.0% of GDP.

Risks To Outlook

The risks to our interest rate outlook are weighted to the upside. The RBI could adopt a hawkish stance and hike interest rates to keep inflation within its target, if price pressures surge due to a significant increase in food prices, coupled with a rapid recovery in economic activity.