Status quo picture emerges for RBI policy in August; here’s why

We are just a week away from RBI’s third bi-monthly monetary policy announcement for the fiscal year FY19 which is scheduled on August 1. This time experts are predicting another rate hike during this policy considering the risk still lies on the neck of India’s CPI inflation. The central bank takes into account inflation for projecting India policy stance, and in the last policy it surprised markets by hiking policy repo rate by 25 basis points to 6.25% from previous 6%. This was first hike in repo rate under Prime Minister Narendra Modi’s government. Now the table will be once again set and all eyes will be watching RBI. However, a report of SBI reveals that a status quo picture once again emerges for India, and the apex bank may just keep repo rate unchanged. 

As per SBI, August rate decision is set to be a close call even though a status quo rather than a hike has emerged as the best option. The only reason for a rate hike by RBI at this juncture might be to satiate the self fulfilling prophecy of market expectations of a rate hike to stem the rupee depreciation (rupee depreciated by 3% post June). 

In SBI’s view, inflation risks are still evenly balanced. While the MSP hike could statistically push up CPI by 73 basis points, such inflation is unlikely to materialize as it is purely subject to procurement by the Central Government/State Government. In fact, without effective procurement, historical trends suggest that market prices have often fallen below MSP due to demand supply dynamics. 

Impact of MSP could also be negated by declining oil prices. HRA impact till date is 37 basis points. However, due to uneven spatial distribution of monsoon food prices might just move up, particularly cereals. But core inflation is expected to gradually come down to 4.5% by end March and the recent data shows that the increase in core inflation is not broad based. 

Further, SBI explained that globally central banks have been withdrawing monetary easing. 

US has already started normalizing its monetary policy with 3rd rate hike expected in Sep’18. Even in Eurozone after Sep’18, monthly pace of net asset purchases will be reduced to €15 billion until the end of Dec’18 and then net purchases will end, subject to the incoming data. 

However, in Japan inflation remains stubbornly low. None of the indicators followed by the Japanse central bank to assess inflation expectations have risen in line with the official inflation target. 

Dr. Soumya Kanti Ghosh, Group Chief Economic Adviser at SBI said, “India has witnessed portfolio outflows, amounting to $6.94 billion during Jan’18-Jul’18 (till 20 Jul’18). The only reason for a rate hike by RBI at this juncture is to satiate the self fulfilling prophecy of market expectations of a rate hike to stem the rupee depreciation.”

RBI in June monetary policy highlighted that, the headline inflation outlook is driven primarily by two countervailing effects. On the one hand, CPI inflation excluding food and fuel rose sharply in April over March by 80 basis points to reach an ex-HRA level of 5.3 per cent, suggesting a hardening of underlying inflationary pressures. 

This, along with an increase in other global commodity prices and recent global financial market developments, has resulted in a firming up of input cost pressures, as also confirmed in the Reserve Bank’s IOS for manufacturing firms in Q2:2018-19. 

The resulting pick-up in the momentum of inflation excluding food, fuel and HRA has imparted persistence into higher CPI projections for 2018-19. On the other hand, food inflation has remained muted over the past few months and the usual seasonal pickup delayed, softening the projections in the short run. 

Taking these effects into account, RBI projected CPI inflation for 2018-19 is revised to 4.8-4.9 per cent in H1 and 4.7 per cent in H2, including the HRA impact for central government employees, with risks tilted to the upside. Excluding the impact of HRA revisions, CPI inflation is projected at 4.6 per cent in H1 and 4.7 per cent in H2.