Inflation worries: RBI to keep rates steady over the next 18 months

Economists expect inflation to be at 5% for the 2017/18 fiscal year

The Reserve Bank of India is expected to keep interest rates steady well into next year after it shifted to a neutral monetary policy stance in February, and despite having raised concerns over a potential spike in inflation, a Reuters poll found.

Earlier this month, the Reserve Bank of India raised a secondary rate while holding the key repo rate steady to mop up excess liquidity from the government's demonetisation drive, making it the fourth meeting in a row it has surprised markets.

The median consensus in the poll of more than 35 economists, conducted between April 10-19, was for the policy repo rate to remain at 6.25 per cent until the fourth quarter of 2018 at least, and the reverse repo rate at 6.00 per cent.

"Inflation continues to be the biggest factor worrying the central bank. Given this, an easy monetary policy stance is ruled out for now," wrote Dharmakirti Joshi, principal economist at Crisil.

Consumer prices rose an annual 3.81 per cent last month, the fastest pace since October 2016, inching closer to the RBI's 4 per cent target, lending weight to the central bank's decision to step away from easing any further.

Economists expect inflation to be at 5.0 per cent for the 2017/18 fiscal year. This compares with the latest predictions from the RBI, which sees the rate at 4.5 per cent in the first half of the year and 5.0 per cent in the second half.

Much will depend on India's monsoon, or rainy season, crucial in a country where most of the population depends on agriculture, and will determine whether food inflation will remain in check.

According to the weather office, India is expected to receive normal rainfall this year and have good distribution, which would ease concerns over farm and economic growth.

While the median consensus in a recent poll was for no change in interest rates until at least 2019, a majority of economists who answered an extra question said the next move by the central bank would be a cut, probably towards the end of this year.

By that time there would be a clearer indication of how the monsoon fares but is in stark contrast to what the central bank has been signaling so far.

Recovery from demonetisation

India's economy is expected to expand at a faster pace in the current fiscal year as the acute effects from last year's currency ban begin to fade.

Prime Minister Narendra Modi's Nov 8 announcement of a ban on high-value bills removed 86 per cent of India's currency in circulation, hurting demand in a largely cash-based economy.

But the economy is bouncing back and gross domestic product in this fiscal year will expand 7.5 per cent and then 7.7 per cent next, economists in the poll predicted.

This compares with the International Monetary Fund's projections of 7.7 per cent for this fiscal year.

As demonetisation was expected to slow growth in the October-December quarter of last year, a 7.0 per cent expansion came as a surprise to markets and raised questions about the veracity of the data.

Factory and services activity contracted in the months following the shock decision, but are now back in expansion mode and at their highest level in five months.

If realised, India will keep its tag as the world's fastest growing major economy, even as the Asia Development Bank predicts developing Asia is on track to post its slowest annual growth in 16 years.