Monetary policy preview: RBI to remain on sidelines with a neutral stance

We expect the Reserve Bank of India (RBI) to keep all key policy rates unchanged, while maintaining a neutral stance. There are several risks to the inflation outlook, which will keep RBI cautious but these risks have all been highlighted in the past and there have been no incremental negative developments in the past few weeks. On the contrary, consumer price index (CPI) inflation has surprised to the downside in February, coming at 4.4 per cent, when the Bloomberg consensus expectation was for 4.7 per cent.

Given the likely inflation trajectory, it is possible that RBI will look through the base effect-led expected increase in inflation during April-June and opt for an extended pause, provided the outlook related to oil prices and monsoon do not turn negative from here. There is, however, a counter-argument that since RBI is an inflation-targeting central bank, it cannot afford to stay on the sidelines, especially when inflation is expected to rise close to 6 per cent, even though led by a base effect. We are not entirely convinced by the latter argument for the following reasons:

Given the recent softer inflation prints, the central bank probably can afford to wait longer, maintaining the current neutral stance, looking for further evidence to ascertain the medium-term oil price trend and monsoon outlook.

Inflation expectations have improved significantly and stabilised below 9 per cent for a year and an extended pause is unlikely to change the expectations dynamic materially, in our view.

Lending rates have gone up by 10-25 bps and if RBI was contemplating a rate hike in the near term, that objective has already been met. 

Given that CPI inflation will come off sharply from the Oct-Dec’18 quarter, a premature rate hike at this stage may prove to be unwarranted, especially if global oil prices and inflation momentum improve more than currently expected, which cannot be ruled out, given the inherent volatility in fuel and food prices, especially in the context of India’s CPI basket.

Kaushik Das, India Chief Economist, Deutsche Bank

Even with an extended pause, real rates in FY19 will remain in the 1-1.4 per cent range, which is healthy enough to ensure macro-stability. 

While growth is recovering, it is still at a nascent stage and needs to be nurtured, as RBI stated in the last policy statement. Between February and now, the January industrial production growth and Oct-Dec’17 gross domestic product growth figures have surprised to the upside but such recovery is on the back of a depressed base and does not change the ‘nurturing nascent recovery’ narrative, in our view. 

The central bank’s decision related to foreign portfolio investors’ (FPI) debt limits will also be watched closely. The expectation is that the FPI debt limit may be increased to 6-8 per cent gradually over the next two to three years from 5 per cent currently. If RBI increases the FPI limit, it will improve bond market sentiments further, in our view. On liquidity, we do not expect any new announcement, but we think open market operation purchases of bonds will likely come back in second half of FY19, as the balance of payments surplus shrinks materially due to a rising current account deficit.

Views expressed are personal