Reserve Bank likely to maintain status quo

Inflows are neutralized with intervention in forward market; $1.5 bn daily intervention seen

The Reserve Bank of India (RBI) is likely to maintain a status quo on key policy rates at its monetary policy review on June 3.

According to experts, though the retail inflation has risen once again in April, there has not been significant uptick in core inflation. Besides, the fiscal stance of the soon-to-be-formed new government will be a key driver before making any changes in the policy stance by RBI.

Foreign institutional investors (FIIs) have been pouring funds in domestic markets, mainly in the equity segment, on the hope that the Bharatiya Janata Party (BJP)-led National Democratic Alliance (NDA) is forming a stable government at the Centre. RBI has been mopping up these flows by intervening in the forward market. (Click for charts)

The strategy is such that it does not add up to the existing money supply due to which risks to inflation are not there. Sandeep Gonsalves, forex consultant and dealer, Mecklai & Mecklai, said: “The huge FIIs flows would have been a concern for inflation only if the money supply would have gone up. And that would have happened only if RBI would have bought the spot dollars and pumped in rupee liquidity. But RBI is buying spot and immediately rolling it over in forwards and paying the premium.”

According to currency dealers, RBI has been mopping up dollar flows of about $ 1-1.5 billion daily in the last few sessions. In March, RBI purchased $8.75 billion from the spot currency market, which prevented the rupee from sharp appreciation. However, from April, the intervention is mostly in the forward segment.

Latest data show RBI’s foreign exchange reserves rose $1.94 billion for the week ended May 2 to $ 311.86 billion. The reserves are near a level last seen in November 2011.

Industrial production shrank for a second straight month in March, falling 0.5 per cent from a year ago, while April CPI-based inflation rose to 8.59 per cent, compared with 8.31 per cent in March. According to market participants, though the retail inflation might rise for another month, it will come down subsequently due to base effect.

The central bank, in its first bi-monthly monetary policy statement, had said GDP was projected to grow in the range of five to six per cent in 2014-15. RBI had also added while monitoring the inflation data, they should look through any transient effects, including base effects. Since September, the repo rate was raised thrice (by 25 bps on each occasion), which now stood at eight per cent. In the last policy review in April, RBI left the rate unchanged.

“With CPI inflation remaining along the expected trajectory and, more important, without any significant uptick in the core inflation, we expect the RBI to remain on a pause on June 3. While RBI may gloss over the transient impacts of weak monsoon on food inflation, it is unlikely to be patient over any signs of any resultant core inflation uptick,” said Indranil Pan, chief economist, Kotak Mahindra Bank.

According to Pan, with policy-driven growth pickup likely, the output gap is also expected to close off in the next fiscal, which necessitates that RBI maintains an anti-inflationary bias. “The fiscal stance of the new government will also be watched carefully to anticipate any change in stance by the RBI,” he added.

A few economists are of the view that the below-normal monsoon projected by India Meteorological Department might lead to one more hike later if not next month. “With risks from the performance of the monsoon, the impact of El Nino, uncertainty over the setting of minimum support prices for agricultural commodities, administered energy prices and still elevated household inflation expectations all skewed to the upside, we expect RBI to deliver at least one more repo rate hike, most probably at the August policy review,” said Mole Hau, research analyst-ecoomic research team at BNP Paribas.

According to the Urjit Patel Committee report, the CPI inflation should be brought down to eight per cent over a period not exceeding 12 months and to six per cent over a period of 24 months before formally adopting the recommended target of four per cent inflation with a band of +/- 2 per cent.