RBI policy: From neutral to cautious?

The Monetary Policy Committee’s (MPC) deliberations on February 6 and 7 will take into account three key concerns: (1) Rising inflation trajectory over the next 4-6 months, (2) Medium term implications from the recently presented Union Budget, and (3) Headwinds from high crude prices and rising global interest rates.

The MPC will likely vote for a pause in this policy meeting as it keenly watches the evolving inflation trajectory. However, the key point to watch for would be the extent of hawkishness exhibited by the MPC.

The MPC will be wary of the inflation trajectory over the next six months. This needs to be seen in the context of a tightening interest rate cycle globally. India’s CPI inflation is due to increase to around 6 percent by June 2018 and from thereon glide down to around 4.5 percent by March 2019. However, the monetary policy will decidedly be on the hawkish side with very little downside visible in the inflation trajectory.

The MPC will also have to factor in the implications of the FY’19 Union Budget. There is significant uncertainty regarding the projected GST revenue buoyancy, as of now. Further, certain proposals such as setting the minimum support price of kharif crops at 1.5X the cost of production, if implemented, can have an upside of around 50-90 bps to baseline inflation.

“We model GFD/GDP at 3.5 percent for FY2019 (a slippage of 20 bps from budget estimates) on the back of revenue slippages and without any commensurate expenditure reduction. The MPC may weigh these concerns along with certain medium- to long-term positives such as the National Health Protection Scheme, the spending on roads and highways, railways, and rural roads, etc.”

A gamut of indicators such as rising inflation trajectory, implications of the budget, high crude prices, and a rising global interest rate cycle will weigh on the MPC as it evenly balances between a long pause and a hiking cycle. However, the MPC will likely prefer to watch through the rising inflation period (a significant adverse base effect) and be cautious on signs of buildup of inflationary pressures, from either domestic or global factors.

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