RBI monetary policy: A hike in Aug but a long pause thereafter, says expert

India’s inflation dynamics have been particularly interesting in recent months. On one hand, headline CPI surprised to the downside, mostly reflecting low food inflation. On the other hand, core CPI accelerated during Q2 18 (April-June). 

Although core inflation is likely to soften from its current level, in the absence of a significant drop in oil prices or a material reversal of the recent uptick in services inflation, it likely will remain above the Reserve Bank of India (RBI’s) comfort zone for several months. Although the RBI is mandated to target headline CPI inflation, which is poised to move lower during H2 18 (July-December) and will likely average a benign 4.6 per cent during 2018-19, the MPC has expressed its discomfort around elevated core inflation, which tends to be sticky.

Given the continued uncertainty in global backdrop and the demonstrated bias of the MPC to remain cautious, the inflation dynamics has increased the likelihood of further tightening in monetary policy. However, given a likely benign headline CPI trajectory in H2 18 and the early stage of the recovery in growth, the RBI’s repo rate hikes will likely be calibrated rather than aggressive. Accordingly, we expect repo rate hikes over the next 12 months to be contained to 50bp (two 25bp hikes). We expect the first of the two hikes in August 2018, followed by a long pause before the second hike, likely in Q2 19. 

Siddhartha Sanyal, Chief India Economist, Barclays

The June hike underscores the MPC’s bias for caution  (31 forecasters, including Barclays, of the 44 surveyed by a Bloomberg poll expected a status quo in June). We expect the MPC’s action to remain data dependent, likely with a continued bias for caution. Apart from inflation indicators, the committee will likely take into account several macroeconomic and financial market indicators (eg, oil prices, the INR, FII flows, monsoon trends). Since the June MPC meeting, FII flows into Indian debt and equity markets worsened further and the INR continued to weaken, while the softening in crude oil prices has been modest. In general, fund flows into emerging markets have slowed in recent months, with both equity and bond funds experiencing outflows.

Finally, monetary policy is set to remain data dependent in the coming months; a rate hike in August will likely be accompanied by a “neutral” monetary policy stance. While elevated global uncertainties have kept the MPC cautious, the recovery in domestic growth remains at an early stage, without concerns of overheating. On balance, despite their inflation target mandate, we expect policymakers to stay mindful of not stifling growth recovery at its current nascent stage.