MPC maintains status quo to guard against looming inflation risks: Expert

As anticipated, the Monetary Policy Committee (MPC) left the repo rate unchanged at 6% in the Fourth Policy Review for FY2018, following the swift rise in the CPI inflation to 3.4% in August 2017 from 1.5% in June 2017. Similar to the last policy review, the decision was split, with one of the six members voting for a 25 bps rate cut, revealing the continuing disparity in the members’ assessment of the evolving inflation-growth dynamics, which may well persist going forward. 

The MPC revised its inflation projection for H2 FY2018 to 4.2-4.6%, including the impact of the revision in house rent allowance (HRA) by the Government of India. It highlighted various risks to the inflation trajectory, including uncertainty related to the volume of kharif output, pending price revisions following the introduction of the goods and services tax (GST), and the recent spike in crude oil prices. It further cautioned that farm loan waivers and pay revision by the state governments could create substantial risks for the inflation trajectory. 

Simultaneously, the Committee sharply reduced its baseline forecast for GVA growth for FY2018 to 6.7% from 7.3%, following the subdued expansion in Q1 FY2018, the year-on-year (YoY) drop in output of most kharif crops estimated by the First Advance Estimate of Crop Production, and the adverse impact of the transition to the GST on volume growth in several sectors. Despite this, it retained the neutral stance of monetary policy, reiterating that its chief focus remains achieving the medium-term inflation target of 4%. 

While refraining from monetary easing as a means to reverse the recent slowdown in various indicators of economic growth, the MPC instead suggested a focus on creation of infrastructure as well as affordable housing, restarting of stalled projects, improvements in the ease of doing business, and simplification of the GST, as avenues to boost growth. It also emphasised recapitalisation of public sector banks, to ensure ample flow of credit to the productive sectors. 

The subdued inflation prints for H1 FY2018 are likely to ensure that the average CPI inflation for this fiscal is sub-4%, suggesting that there is room for an additional policy rate cut of 25 bps. However, given the expectation that headline inflation would rise further, and exceed 4% for much of H2 FY2018, the likelihood of further monetary easing in the current year appears decidedly low, in our view.

The author is principal economist, Icra