RBI holds rate, cuts H1 inflation forecast to 4.7-5.1% on lower food prices

RBI lowered its inflation projection sharply from previous forecasts, but flagged risks on the upside on revised numbers

The Reserve Bank of India (RBI) on Thursday adopted a remarkably dovish tone, surprising analysts who were expecting the firming up of rates in the medium term, even as one of the six members in the Monetary Policy Committee (MPC) voted for a hike in an otherwise status quo policy. 

After the first bi-monthly monetary policy for 2018-19, the repo rate remained at 6 per cent. RBI Executive Director Michael Patra voted for a 25 basis points hike, but other five members, including RBI Governor Urjit Patel favoured a pause. 

The central bank lowered its inflation projection sharply from previous forecasts, but flagged risks on the upside on the revised numbers. The RBI expects retail inflation in March at 4.5 per cent, down from 5.1 per cent it projected in February. 

“The inflation prints for February (at 4.44 per cent) did turn out to be softer than our projection,” RBI Governor Urjit Patel said in a post-policy conference. “However, the MPC looks ahead and we noted that there are several uncertainties around the base-line inflation path, which is why we kept the stance neutral and the rate unchanged.” 

Photo: Kamlesh Pednekar

Inflation for 2018-19 is now projected at 4.7-5.1 per cent in the first half of 2018-19 and 4.4 per cent in the second half, including the house rent allowance (HRA) for central government employees. The earlier projection was 5.1-5.6 per cent in the first half and 4.5-4.6 per cent in the second, including the HRA impact, according to the policy statement. In the accompanying Monetary Policy Report, the RBI said: “The direct impact of the increase in the HRA announced by the central government fades away fully by December 2018.”

Excluding the impact of HRA revisions, the RBI projected CPI (consumer price index) inflation at 4.4-4.7 per cent in the first half and 4.4 per cent in the second. 

At the same time, the RBI said “there are now clearer signs of revival in investment activity”. It expected growth to be significantly better than last year. 

“On the whole, GDP (gross domestic product) growth is projected to strengthen from 6.6 per cent in 2017-18 to 7.4 per cent in 2018-19 — in the range of 7.3-7.4 per cent in H1 and 7.3-7.6 per cent in H2 — with risks evenly balanced,” the policy statement said.

Economists saw the sharp downward revision of inflation and upward projection of growth as a sign that the central bank could be positioning itself for a possible cut. Economic Affairs Secretary Subhash Chandra Garg said the MPC revised upwards its forecast of GDP growth broadly in line with that in the Economic Survey. "The government welcomes the policy statement,” Garg said.

The bond market reacted positively, with the 10-year bond dipping to close at 7.127 per cent, from its previous close of 7.294 per cent. Fall in yields is an indication of the market preparing for a rate cut. Overall, the system liquidity is expected to remain in a “moderate surplus mode in the first half of 2018-19, and the evolving liquidity condition will determine our choice of instrument for a transient and durable liquidity management”, RBI Deputy Governor Viral Acharya said.

The tone was far dovish than what the market and analysts expected. “The RBI has an uncanny knack of surprising the market and this policy was just the right occasion. With a significant downwardly revised inflation projection and upwardly revised GDP growth, the stage is set possibly for robust surprises if the script works as per projections,” said Soumyakanti Ghosh, group chief economist of State Bank of India. 

Even if there is no rate cut, the dovish policy “suggests no imminent policy tightening”, said Nomura, which expressed surprise on the downward revision of inflation.

A chief economist of a foreign bank said the General Election next year does force the RBI to give a boost to growth, at the cost of skewing inflation a little on the higher side. Even as the revised inflation forecast is above its own central target of 4 per cent, the RBI is keeping all its options open for now, as the Centre might demand a monetary boost to growth before heading for the polls, the economist said. 

RBI did mention some risks to its inflation forecasts, and some of those fall in uncertain territories. The revised formula for Minimum Support Price for kharif crops may have an impact on inflation, but the magnitude would be known only in the coming months. Fiscal slippages, both from state and Centre, pose a challenge. Both input and output prices of manufacturing companies would rise going forward, while crude prices have imparted “a fair bit of uncertainty”, said Patel.

“For these reasons, we have continued with the status quo, and risks tilted to the upside. We will closely monitor the evolution of these handful of factors and how they impact inflation,” Patel said.

According to Ghosh of SBI, the “spectre of upward surprises to inflation is unlikely to materialise as HRA increases by states has been much lower than consensus. Add to that the empirical evidence of oil price hike and its impact on headline inflation getting divorced as wage growth continues to be muted. Fiscal impact on inflation is unlikely with excess capacity.”  

The RBI also proposed to allow non-residents to access the rupee interest rate swap (IRS) market in India, in order to “tap into the active offshore rupee interest rate swap market to add depth and liquidity in the domestic interest rate swap market”, said Acharya.  

Also, the RBI said all payment service providers should have their data stored in India, in order to have effective surveillance.

Among other major measures taken in the policy, the RBI said entities regulated by the central bank, must immediately stop dealing with, or provide services for, any individual or entities dealing in virtual currencies such as bitcoins. However, the RBI is not averse to the block-chain technology and sees good in it. Based on the technology, the central bank is now mooting to introduce the country's own fiat digital currency, said BP Kanungo, RBI deputy governor.