RBI Policy: MPC may keep policy rate unchanged at 6%; owl may sound hawkish

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Urjit Patel, Governor of the Reserve Bank of India (RBI), and his five colleagues on the Monetary Policy Committee will not find it too hard to keep the key policy interest rate unchanged at the upcoming policy review on February 7.

The 2-day deliberations on February 6 and 7 by the MPC on the repo rate decision are expected to remain tilted towards a pause mode, keeping the near term outlook hawkish.

However, they may raise rates later given the risks of higher inflation with fiscal slippages and higher food prices with the government planning to increase the Minimum Support Price (MSP).

In the Budget last week, the government promised to ensure MSP of key crops at 1.5 times the cost of production. This could mean at least a 50-70-basis-points increase in the headline inflation number.

While banks and bond markets have already signaled the end of the interest rate easing cycle, the MPC may keep the repo rate unchanged at 6 percent.

Inflation risks

Although, experts suggest the inflation-wary RBI, is likely to flag both factors — risk of higher MSP and slower fiscal consolidation — as a medium-term risk to inflation.

Saugata Bhattacharya, Chief Economist of Axis Bank said, “All the risks that the RBI had listed out (in December) still remain. Also, fiscal slippages that we may see are not significantly alarming, so that may not change things for the central bank. They will mention the risks, even more heightened now that the commodity prices are much beyond what they were in December. So the tone will be hawkish…”

With the rise in crude oil prices, coupled with a rise in prices of vegetables, India’s consumer price index (CPI) or retail inflation shot up from just under 2 percent in June 2017 to a 17-month high of 5.21 percent in December.

The government has said the fiscal deficit in 2017-18 will be 3.5 percent, higher than the budgeted 3.2 percent at the start of this fiscal, which is seen as a negative by the bond and equity markets, and already reflected in higher yields and falling stock prices in the wake of the Budget.

End of lower interest rate regime?

Despite the easing of interest rate cycle almost nearing its end, Bhattacharya ruled out the possibility of RBI’s shift of ‘neutral’ stance to ‘restrictive’ as “inflation may come down around June, and GDP growth is still low”.

Keki Mistry, Vice chairman and CEO of largest private home financier HDFC, said, “Clearly, rates have bottomed out but I don’t see rates increasing in a hurry. They will remain static for the next 3-4 months and a host of factors that are not under our control will determine the way forward.”

He added that the stance may change if there is a big slippage in fiscal deficit “though, I do not expect it to happen”.

The central bank, in its last policy review, had warned about inflation remaining elevated, causing numerous market participants to factor in a rate hike sooner rather than later. Most experts don’t see the rates going into the low interest rate regime any time soon.

However, the optimistic Finance Minister Arun Jaitley, in an interview post Budget said the price of crude oil is an unpredictable factor, and conventional wisdom doesn’t do much good when it comes to predicting where it will go.

Although the owlish RBI may not be as optimistic, they may not be in a position to show tough love to government for now and keep the rates unchanged at 6 percent for now.moneycontrol