Monetary Policy Review - April 2018
RBI maintains status quo
As widely expected, RBI's Monetary Policy Committee (or MPC) maintained a status quo on policy rates and retained a neutral monetary policy stance. Consequently, the repo rate stands at 6%, the reverse repo rate at 5.75% and the Marginal Standing Facility (MSF) rate and Bank rate at 6.25%. Five members voted in favour of the monetary policy decision and one member voted for an increase in policy rates by 25bps. The MPC reiterated its commitment to keep headline inflation close to 4 per cent on a durable basis.
RBI revised its projection for CPI inflation to a range of 4.7% - 5.1% in H1 (previous projection range of 5.1% to 5.6%) and 4.4% in H2 (previous projection range of 4.5% to 4.6%), including the HRA impact for central government employees, with risks tilted to the upside. The statistical impact of the HRA revisions will be looked through, accordingly after excluding the statistical impact, CPI inflation is projected in a range of 4.4% - 4.7% in H1:2018-19 and 4.4% in H2. This revision reflects recent softening in food prices, signals from the RBI's forward-looking surveys, and estimates from structural and other models.
The MPC also outlined several factors that make the inflation outlook uncertain on the upside. These include international crude oil prices which has been volatile in the recent period. Revised guidelines for arriving at minimum support prices (MSP) for kharif crops announced in the Union Budget. The staggered impact of HRA increases by various state governments pushing up headline inflation and potentially inducing second-round effects (i.e. inflation in other items due to HRA increases). Besides, any further fiscal slippage (both at central and state levels) from the budgeted estimates for 2018-19 and non-normal monsoon may have a significant bearing on inflation outlook.
RBI also revised its growth outlook and switched to GDP as a headline measure of economic activity. GDP growth for 2018-19 is now projected at 7.4% overall – in the range of 7.3%-7.4% in H1 and 7.3%-7.6% in H2 with risks evenly balanced. The outlook would be influenced by several factors including stabilization of GST implementation which augurs well for growth, signs of improvement in credit off-take which signifies revival in manufacturing sector and new investment activity, and large resource mobilization from the primary capital market which could strengthen investment activity. The process of recapitalization of public sector banks and resolution of distressed assets under the Insolvency and Bankruptcy Code may improve the business and investment environment. Focus on rural and infrastructure sectors in the Union Budget could revive rural demand and crowd in private investment. Export growth is expected to improve further on account of improving global demand, although elevated commodity prices may act as a drag. However, there are two major risks to the growth outlook. First, protectionist trade measures announced by US and threat of a trade war. Second, the uncertainty over the pace and timing of monetary policy normalisation by the central banks in advanced economies which may have an adverse impact on capital flows and overall investment sentiment.