MPC minutes: RBI may have lost its only dove as talk of rate hike swirls

MPC member Patra voted for rate hike due to inflation outlook

Members of India’s rate-setting committee are concerned about the inflationary impact from Prime Minister Narendra Modi’s expansionary budget, minutes of the February central bank policy meeting showed.

Most of the six members of the monetary policy committee turned hawkish at the Feb. 6-7 meeting, when the central bank decided to keep the benchmark repurchase rate at 6 percent. One member voted for an interest rate hike while another, known from his dovish stance, gave up his call for a cut, dashing any lingering hopes that the central bank could still ease policy in coming months.

Governor Urjit Patel said there were several upside risks to inflation, while his deputy Viral Acharya noted that if growth remains robust and inflation prints continue to be well above the target of 4 percent, a change in stance from "neutral" to "withdrawal of accommodation" might have to be considered. Another central banker, Michael Patra voted for a quarter-percentage-point hike, according to the minutes published Wednesday.

The RBI’s neutral stance earlier this month brought relief to the bond market, which has endured the worst sell-off in two decades.

And with Ravindra Dholakia jettisoning his rate cut call, bond investors who are grappling with tight liquidity conditions are slowly accepting the next move will probably be a hike. The swaps market showed investors are betting the central bank will raise the key rate to at least 6.5 percent before the end of 2018.
 

"Fixed income markets are telling us that we have fallen behind the curve," said Patra. "The target is in danger of getting out of reach and over the next few months, the upper tolerance band is under threat. This could seriously dent the credibility of the committee’s commitment to the target," he said of inflation.

The RBI is forecasting inflation for April to September at 5.1 percent to 5.6 percent before easing to 4.5 percent to 4.6 percent for the second half of the financial year, although risks are tilted to the upside. The bank’s goal is to keep headline inflation close to 4 percent over the medium term.
 

The central bank expects gross value added -- a key measure of growth -- to increase 7.2 percent next fiscal year from 6.6 percent this year. Forward-looking surveys show there’s still slack in the economy though, with capacity utilization at 71.8 percent in the second quarter of 2017/18. While consumer confidence is sluggish, household inflation expectations remains elevated, underlining the RBI’s hawkishness.

Budget Pangs

Earlier this month, Finance Minister Arun Jaitley presented a budget that boosted spending in a bid to placate angry voters before next year’s general election. It also included higher procurement prices for food grains from farmers and hiked custom duties to boost domestic manufacturing.

The spending boost meant India will miss its fiscal deficit target with the budget shortfall at 3.5 percent of gross domestic product in the year ending March 31, wider than the previous 3.2 percent target. The government will aim for 3.3 percent next year rather than its earlier 3 percent goal.

"Impact of the increase in customs duty and MSP proposed in the budget on the headline inflation is again uncertain," said Dholakia.

Another MPC member Pami Dua cited the decision to raise procurement prices for farmers as a risk to inflation. This warranted "a wait and watch strategy with status quo in policy interest rate and a neutral stance is currently recommended."

"A normal monsoon along with reasonable MSP hikes may imply RBI will hold rates," said Sameer Narang, chief economist at Bank of Baroda. "However, members are prepared to raise rates if upside risks to inflation materialize."