India Monetary Policy February 2018

India: Central Bank keeps rates unchanged in February

The Reserve Bank of India (RBI) stayed put at its meeting on 7–8 February, as officials retained their neutral policy stance while acknowledging multiple upside risks to inflation. Five out of the six monetary policy committee members decided to keep the repo rate unchanged at 6.00%, the marginal standing facility (Bank Rate) at 6.25% and the reverse repurchase rate at 5.75%. The dissenting member of the committee voted for a 25 basis-point hike to all three rates. Although the Bank’s decision had been expected by market analysts, officials’ neutral stance came as a surprise and caused bond yields to pull back amid market relief that the Bank did not adopt a more hawkish tone.

The RBI’s decision to keep rates on hold came in spite of a marked acceleration in inflation in recent months, which resulted from stronger-than-expected food prices, a rise in prices at the pump and higher home rent allowances (HRA) allocated to public sector workers. In light of these recent developments, the Bank revised up its inflation projection for the last quarter of FY 2017—which runs to March 2018—to 5.1% from the 4.3–4.7% previously forecast for H2 FY 2017. For FY 2018, the Bank expects inflation to come in at 5.1–5.6% in the April-to-September period before easing to 4.5–4.6% in the October-to-March period, thus overshooting the Bank’s 4.0% inflation target for the whole year.

In addition, the Bank highlighted upside risks to its inflation outlook, including the staggered impact of HRAs, rising oil and commodity prices on the back of stronger global growth, the budget calling for customs duties increases, and fiscal slippage. The RBI also stressed the government’s recent decision to increase Minimum Support Prices (MSP) for kharif crops as an upside risk to inflation but acknowledged that it is still waiting for more clarity on the MSP mechanism. Conversely, officials highlighted some factors that weighed on inflation expectations, including subdued capacity utilization and moderate wage growth in rural areas.

Meanwhile, domestic economic conditions have been generally positive as the manufacturing and service sectors have displayed upbeat business activity in recent months. The Bank projects GVA growth to improve in FY 2018 and reach 7.2%, above the 6.6% growth figure it expects for the current fiscal year. This improvement is expected to be driven by an easing of the GST compliance burden, increasing private investment activity, credit expansion and a buoyant export sector.

Despite the deterioration on the inflation front and a more upbeat assessment of the economy, the RBI stayed on hold with a neutral stance and maintained its data-dependent guidance. This suggests the Bank is looking beyond the inflation overshoot in the near term and may only act if inflation displays a trend that is not consistent with its 4.5% forecast by late FY 2018. This allayed concerns among market participants, who had expected the RBI to sound more hawkish following measures presented in the FY 2018 budget—including the increase in MSPs—that are inflationary in nature. Nonetheless, as growth picks up and if inflation risks materialize during the course of FY 2018, the Bank may reassess its views and adopt a more hawkish rhetoric.

The next monetary policy meeting is scheduled for 4–5 April.

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