RBI monetary policy: Hike as expected; next increase likely in 2019

July CPI print is likely to be below 4.5% and could even touch 4%, if food prices rise by 1% month-on-month, in line with previous month's trend

As expected, the RBI delivered a 25bps rate hike in the August policy, while maintaining a neutral monetary stance. RBI, in our view, has done the right thing by front loading rate hikes in June and August and can now be expected to remain in a wait and watch mode for a considerable period of time. We see the next 25bps rate hike happening only in April 2019 based on our forecast of inflation and growth. Only if the pressure on currency increases significantly in the coming months, then the RBI could be compelled to bring forward the rate hike to December 2018 or February 2019; otherwise the central bank, in our view, will continue to be on the sidelines for an extended period of time. 

The RBI provided its latest CPI inflation projections, which pegs July-Sep’18 at 4.6 per cent, 4.8 per cent in October’18-March 2019 and 5 per cent in April-June’19. We think headline CPI inflation has potential to surprise to the downside in the rest of this calendar year, led by lower than anticipated increase in food prices. The July CPI print is likely to be below 4.5 per cent and could even touch 4 per cent, if food prices rise by 1 per cent month-on-month, in line with previous month’s trend. This has the potential to push down the headline CPI inflation trajectory and result in a lower average for July-September 2018 and Oct-December 2018. We are forecasting CPI inflation to ease to 4 per cent by end-December 2018 and then rise gradually toward the 5 per cent mark by April-June 2019. Consequently, we see RBI hiking the policy rate next only in early 2019, as CPI shows signs of inching higher toward the 5 per cent mark. 

There are a number of risks that can play spoilsport but with the RBI already having delivered 50bps rate hikes in a short period of time, the urgency for following through with further rate hikes in the next few policies diminish, in our view. This will also get corroborated by the slowdown in the pace of growth recovery that will ensue post July-Sep’18, as the base effect becomes less favourable. 

Note, however, that core CPI inflation is expected to be 100bps higher in FY19, compared to the previous fiscal and the RBI would need to hike policy rate at least 75bps incrementally, to temper demand side inflationary impact and rising inflation expectations. In that sense, the RBI is not done with rate hikes yet, but looks to be entering a period of extended pause, before it goes for at least one more 25bps rate hike in early 2019. 

As far as liquidity outlook is concerned, the fact that the central bank has kept its monetary stance neutral, signals that OMO purchases will continue (probably at a faster pace from 2HFY19) to ensure money market liquidity remains at neutral levels on a durable basis. We do not find OMO purchases inconsistent with RBI hiking rates, as the former action is informed by the need of supporting reasonable reserve money growth, in the backdrop of a likely sizable BOP deficit in FY19.

The author is India Chief Economist, Deutsche Bank. Views expressed are personal