Data-dependent RBI remains on hold with a neutral stance: Expert

The RBI’s decision to remain on hold, while maintaining a neutral stance was in line with our expectations. As in the past, the monetary policy statement continued to highlight potential upside risks to inflation that could manifest on account of fiscal spill-over risks due to implementation of farm loan waivers, possible increase of salaries and wages by different states in the period ahead, international crude oil prices rising further, and possible firming of core inflation. In the post-policy press conference, Urjit Patel stated that the RBI would wait and watch the evolution of inflation over the next 6-7 months, given the large bound of uncertainty surrounding the outlook. This indicates that RBI is not in a hurry to consider easing rates further at this juncture. 

Having said that, the statement also does not close the door completely for potential monetary accommodation, with the central bank keeping the optionality of easing if the macro conditions warrant such an action at a future stage. Clearly, RBI does not want to act in a knee-jerk manner in response to the sub-6% GDP out-turn in April-June, which can be attributed largely to short-term disruptive impact of GST. The policy statement also lists down a number of supply side measures and structural reforms that should be expedited to reduce the negative output gap in the economy. Basically, RBI seems to be suggesting the current growth slowdown cannot be tackled effectively through additional cuts, and it is better to rely on structural measures (recapitalisation of banks, simplification of GST, restarting stalled investment projects, expediting the roll-out of the affordable housing programme) to revive growth towards potential. 
 

On the fiscal front, RBI cautioned against further relaxing the central government’s fiscal deficit target, given that India’s general government deficit is still relatively elevated at over 6% of GDP.

In our base case scenario, we are not expecting RBI to cut rates any further, but we do see it maintaining the policy repo rate at 6.0% for a prolonged period. For further rate cuts to happen, a number of conditions will need to be met simultaneously: Headline CPI and core CPI inflation should surprise to the downside relative to the baseline estimates, July-Sept GDP growth should disappoint materially, the government will have to stick to its FY18 fiscal deficit target of 3.2% of GDP; and global financial market conditions need to be stable, even with the balance sheet unwinding programme of the US Federal Reserve. Given so many moving parts and competing considerations, the room for further rate easing remains low, but even maintaining the repo rate at 6% for an extended period will help support real economic activity, in our view.

The author is India chief economist, Deutsche Bank. The views expressed are personal.