Further monetary easing in 2016 likely to be limited to 25 bps

The Reserve Bank of India (RBI) had chosen to restrict its repo-rate cut to 25 basis points (bps) in its April 2016 policy review, as we had anticipated. Subsequent data flow seemed to challenge this decision. Consumer Price Index (CPI)-based inflation for March had declined to 4.8 per cent, retreating below RBI's target of five per cent a year ahead of schedule.

Moreover, the India Meteorological Department (IMD) forecast of an above-normal monsoon has brought cheer to the farm sector, reeling from consecutive unfavorable monsoons. However, the hasty rise in retail inflation in April to 5.4 per cent confirms that the RBI's decision not to front-load a larger rate cut was indeed appropriate.

IMD's subsequent caution of a delay in monsoon arrivals has brought the spotlight back to the temporal and spatial spread of rainfall, not only its volume. The delayed precipitation presages a persistence of the seasonal hardening in prices of perishable foods and a postponement in sowing of the next crop, until rains cover a significant portion of the country, particularly given the low reservoir storage levels. Nevertheless, the area sown under kharif crops is expected to rise in 2016, on the back of higher precipitation, particularly in the later portion of the monsoon season, which would eventually cool inflationary pressures.

The renewed expectation of multiple rate increases by the US Federal Reserve this year would impart strength to the dollar, weakening the rupee in its aftermath. This, in conjunction with the recent rise in commodity prices would increase the landed prices of imports. For instance, the price of the Indian crude oil basket has averaged $44 a barrel in May, higher than our baseline forecast of $42 a barrel for FY17. The impact on inflation and fiscal metrics would be influenced by whether some of the earlier excise hikes on petrol and diesel are reversed.

The revision in pay scales of central government employees would offer succour to the manufacturing sector, which has seen a contraction in volumes in four of the past six months. However, inflationary pressures arising from the expected boost to consumer demand cannot be written off, given the stickiness of services inflation.

On balance, RBI is likely to leave the policy rate unchanged in its coming review. Even if the eventual monsoon dynamics are successful in dampening food inflation, the space for further monetary easing in 2016 would be limited to 25 bps.

The author is senior economist, ICRA Ltd