Repo rate likely to remain unchanged: ICRA

MPC may observe monsoon progress and GST transition before taking a decision, says ratings agency

The repo rate is likely to remain unchanged in the upcoming policy review in June 2017 by Monetary Policy Committee (MPC) of  the RBI and the policy tone to be less hawkish, predicts ratings agency ICRA. Naresh Takkar, Managing Director and Group CEO, ICRA accounts this to “the improved outlook for the monsoon, rate structure of the goods and services tax (GST) and easing of commodity prices”, which have subsequently abated the inflation risks highlighted by the MPC in April 2017.

“The MPC may choose to observe the actual progress of the monsoon and the adjustment during the transition to the GST, prior to reducing the policy rate or reversing the stance back to accommodative from neutral. Therefore, we expect the MPC to opt for a pause in the June 2017 policy review," said Takkar. He also listed the CPI rate not falling under 4% (the medium term target) for six consecutive months and visible improvement in volume growth in a number of sectors post-remonetisation as factors for not cutting the repo rate.

The year-on-year (YoY) CPI inflation, led by food inflation, eased sharply to a series-low of 3% in April 2017. Moreover, the core-CPI inflation (excluding food & beverages and fuel & light) declined to 4.5% in April 2017 from 4.9% in March 2017.  

While the improved monsoon prospects have subdued concerns about food inflation, the dip in reservoir levels and extent of revision in minimum support prices (MSPs) remain modest inflation risks. Food inflation is expected to be relatively benign in H1 FY2018 but a reversal of base effects could result in food inflation rising sharply to 4-5% during H2FY17.

ICRA expects the impact of the implementation of the GST on the CPI inflation to be modest. However, it predicts housing inflation to rise in the ongoing fiscal due to the imminent revision in house rent allowance. Migrants returned to their villages expecting loss of jobs in urban less-formal sectors but the rural wage inflation still rose sharply to 6.6% in January 2017 from 6% in December 2016. Subsequently, March 2017 has seen a marginal dip to 6.4% in wage inflation, suggesting stickiness in wages going forward.

Factoring in the Indian Meteorological Department’s monsoon projection, the expectation of a moderate hike in MSPs, stable global commodity prices and a modest weakening of the rupee, ICRA expects the CPI inflation in FY18 to average 4-4.3%, lower than its earlier assessment of 4.5%, while exceeding the 4% level being targeted by the MPC. Nevertheless, the CPI inflation is likely to slope up over the course of the fiscal, partly on account of an unfavourable base effect in the later months, following MPC’s indication in the last policy review.

In April 2017, the MPC had indicated that the CPI inflation is likely to average 4.5% in H1FY18, before rising to 5% in H2FY18, with risks evenly balanced around this projected trajectory. With greater emphasis on bringing inflation in a durable manner to 4%, the mid-point of the CPI inflation band of 2-6.0%, ICRA expects the MPC to maintain status quo on the repo rate in the June 2017 policy review. The MPC may revise its CPI inflation outlook for FY2018 in the upcoming policy meeting due to easing of some inflation risks. Additionally, release of the updated FY2017 growth figures by the Central Statistics Office on May 31, 2017 may lead to the MPC revisiting its growth forecast of 7.4% for FY2018.