Steady as she goes: Sonal Varma

Most fundamental drivers of inflation suggest that a gradual disinflation should continue

RBI's decision to stay the course on monetary policy was on expected lines. In our view, the key goal of the policy communication was to re-align market expectations, as the June policy guidance was (incorrectly) interpreted as dovish.

In this backdrop, the forward guidance suggests that while RBI is relatively confident of meeting the eight per cent inflation target by January 2015, it sees upside risks to the six per cent CPI target by January 2016 i.e. it is in no rush to cut rates.

Most fundamental drivers of inflation - minimum support prices, nominal rural wages - are on a downward path, suggest that a gradual disinflation should continue. However, there are risks.

The supply side response of the government in addressing food inflation and in de-bottlenecking investments remains to be seen.

Whether high food inflation, currently driven by vegetable prices, translates into high core inflation, is an uncertainty.

Additionally, a number of prices on products such as LPG, kerosene, fertiliser and electricity are still suppressed, and as they are released, will add to inflation in the coming quarters, though they are a medium-term positive.

Hence, even as the growth outlook is much more optimistic, whether higher growth will short-circuit this disinflationary process is something the RBI would like to assess before committing to lowering rates.

In our view, the central bank is unlikely to ease rates unless there is visibility of attaining and sustaining the next target of "6 per cent by January 2016". Cutting rates too early could be tantamount to a policy flip-flop, a mistake RBI should be wary of committing.

Overall, while the next move on policy rates is most likely a cut, RBI is likely to remain on a prolonged pause. This period of policy stability should result in continued disinflation, higher real rates and the rebalancing of the economy, all of which augurs well for medium-term fundamentals.

Sonal Varma
Executive Director and India Economist, Nomura