Polls, monsoon to shape policy path in FY15

The RBI looks set to keep the key interest rates on hold in next week's policy meeting. However, the course of monetary policy in the latter part of the year remains far less certain. Inflation had been the central bank's key focus area, which, after a much volatile 2013, has started moving lower recently.

The most recent inflation headlines - both wholesale and retail - are relatively comforting. In the absence of any major disappointment from the monsoon, retail inflation might average closer to seven per cent in 2014-15, in my view, lower than the central bank's early-2015 target of eight per cent. Despite the modest inching up of late, core inflation prints (WPI) are also not high when seen against historical trends. In fact, while there would be the impact of a relatively unfavourable base in the next three-four months, the persisting sub-par growth momentum, large spare capacity in the manufacturing sector, a lack of pricing power within industry, and the recent stability in the rupee limit upside pressures on core inflationary trends in the economy.

As such, RBI has indicated that rates are appropriate now, but CPI-based inflation and inflation expectations will need to be lowered over time. In fact, the central bank shows a strong inclination to adopt the recommendations of the Urjit Patel committee on the revamp of the monetary policy framework.

However, given the longer-term impact it might have on the country's economy, the new government's economic policies will ideally have to come in sync with that of the central bank before a formal adoption of the new regime. On balance, we expect the RBI to stay on hold in the near term, while the election outcome and the new government's economic policies will likely have a material influence on the course of monetary policy during the second half of 2014. While not a structural factor, monsoon will also have an influence on the course of monetary policy, especially given the RBI's recent focus on retail inflation.

The writer is chief India economist, Barclays