MPC provides stimulus noting receding inflation risks

In a first, MPC did not refer to the second round effects through demand conditions from HRA hike

The monetary policy committee (MPC) delivered a 25-basis point cut in the repo rate to six per cent, as was largely expected. Of the six members, five including Governor Urjit Patel, voted for a cut, while one member voted for a status quo. The stance on the policy remains neutral, indicating caution.

The statement acknowledged upside risks to the RBI’s inflation target of 4 per cent seen over earlier meetings, have either receded or have not materialised. That is evident from the fact that core inflation has been easing for the past three months. The new baseline inflation projection puts headline CPI inflation at just over 4 per cent, excluding the statistical impact of the HRA (house rent allowance) increase for central government employees. In fact, the MPC for the first time did not refer to the second round effects through demand conditions from the HRA hike and looked at it as a purely statistical impact on housing and CPI inflation. These factors opened up room for monetary stimulus in order to support growth, in line with past RBI guidance for real policy rates around 1.75 per cent.

The statement, however, also cautioned that headline CPI inflation would henceforth be on a rising trajectory, as base effect support fades from August and there are visible signs of prices hardening in key food categories. Even some hardening of 3-month and 1-year ahead inflation expectations of households, was seen in the June round of the survey. These considerations coupled with the fact that HRA increases by states can add another 100 bps to headline inflation over the next 18-24 months and the difficulty in differentiating between transitory and structural factors driving food inflation, warranted caution and a neutral stance.

On growth, GVA growth forecast of 7.3 per cent for FY2017-18 has been retained, though the statement notes that the underlying growth impulse in the non-farm economy is weakening. This too seems to have influenced the MPC to provide monetary accommodation.

The Committee noted that there was an urgent need to revive private investment. In fact, a weaker growth profile in the first half of the year could spill over to the second half. And, that may lead to CPI inflation remaining around four per cent by Q4 with a softening bias. That can provide some more room for monetary easing.

Another 25 bps rate cut in the December or February 2018 policy meeting appears possible.

Views expressed are personal