Sensible call

The sixth and final monetary policy statement of the Reserve Bank of India for fiscal 2017-18 held no surprises, as expected. Though the stance continues to be neutral and the rates are unchanged, the language appears just that bit hawkish when the central bank refers to factors that may yet cause inflation to spike in the second half of the next fiscal. The policy statement tilt, the present conditions in the bond market where rates have hardened by about 70 basis points in the last couple of months, and liquidity conditions gradually reverting to neutral from excess, clearly point to the inevitability of a reversal in the rate cycle soon. The decision to offer a higher minimum support price to farmers and the slippage in the fiscal deficit for this fiscal, both courtesy the Budget presented on February 1, may only hasten the process. A rate hike appears clearly on towards the third quarter of 2018-19, if not earlier.

The central bank has projected inflation rising to between 5.1 and 5.6 per cent in the first half of 2018-19 and though it is expected to moderate to 4.5-4.6 per cent in the second half, the risks are tilted to the upside. Crucially, one of the factors underpinning the softer projection is that the monsoon will be favourable and that food prices will remain soft. It is early days yet to comment on the monsoon but food prices have traditionally hardened in the summer and monsoon months even if monsoons have been favourable. Fuel prices have been a big factor in pushing up the CPI and with the Centre clear that it will not interfere in fuel pricing, crude oil prices will continue to be a major influence on overall inflation. The good news though is that crude prices have pulled back after touching the $70-a-barrel mark and are now trading well below that, in the $66-67 range. It is likely that oil prices will trend lower as winter demand for fuel eases and production picks up, especially in the US.

What might yet hold the central bank’s hand from raising rates in the immediate term is what it calls the “nascent recovery” and the need to “carefully nurture” the same. Encouraged by positive news that came in after the CSO pegged its first advance estimate of GDP growth for this fiscal at 6.1 per cent, the RBI has projected growth at 6.6 per cent for this fiscal and at 7.2 per cent for 2018-19, which is at the lower end of the estimate made in the Economic Survey . Early signs of an investment revival, improving credit offtake and rising capital goods output seem to have enthused the MPC which has at least for now privileged growth over inflation. This is sensible policy as a premature reversal of the rate cycle will only serve to harm the incipient recovery process. The policy stance might also serve to calm the bond markets and pull back yields, which had moved up in anticipation of onset of the rate-tightening process.

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