At last, no surprises
Guest Column: Abheek Barua

In its final monetary policy meeting of 2018, the RBI decided to keep the policy rate (Repo rate) unchanged at 6.50 per cent. The decision was unanimous (all members voted in favour of hold) and was in line with market expectations.

Sharp correction in oil prices since the last MPC meet in October, softening of inflation expectations, and easing of depreciation pressures for the rupee are the main factors that led the RBI to keep the policy rate unchanged.

As anticipated, the MPC revised down its inflation forecasts for 2H-FY19, from 3.9-4.5 per cent to 2.7-3.2 per cent. For FY20, the MPC expanded its forecast horizon and provided an inflation estimate of 3.8-4.2 per cent for 1H-FY20. In the October policy, the committee highlighted 4.8 per cent as an estimate for 1Q-FY20.

Despite downward revision in its inflation forecasts, the MPC decided to keep its policy stance unchanged at “calibrated tightening”. The MPC highlighted the risk of “sudden reversal” in food prices, uncertainty regarding the impact of new MSP policy (around 24 per cent hike announced by the government for the current kharif season), volatility in oil prices and global financial markets as the main reasons to keep its stance unchanged.

On growth, the RBI retained its annual forecast for FY19 at 7.4 per cent. However, unlike the last policy where the MPC mentioned that risks to growth were “broadly balanced”, this time the language was changed to “risks somewhat to the downside”.

On liquidity, the MPC mentioned that the CRR policy is not in their ambit and kept it unchanged. Moreover, the statement highlighted the reliance on other measures to infuse liquidity into the system. OMO purchases to the tune of Rs 36,000 crore in October and Rs 50,000 crore in November were highlighted as some of the measures taken in the recent past to avoid liquidity crunch in the domestic markets. Meanwhile, the SLR (statutory liquidity ratio) was cut from 19.5 per cent to 19.25 per cent, effective January 2019. However, this is unlikely to have any major impact on the domestic liquidity situation, as commercial banks will have to simultaneously comply with the minimum LCR of (liquidity coverage ratio) of 100 per cent by January 1, 2019. Just to recall, reduction in SLR is part of the long-term road map to align it with the LCR requirement. Further, as part of this road map, the RBI announced that SLR will be reduced by 25 bps every calendar quarter until the SLR reaches 18 per cent of NDTL.

Change in ‘stance’ likely next time

As highlighted in the policy statement on Wednesday, one of the members of the MPC suggested a change in policy stance to “neutral”. Given the downside risks to growth, we believe that some more members could tilt towards a change in stance by the next meeting in February. During the press conference, governor Urjit Patel also hinted that the conditions are gradually changing and they await for more robust inflation signals to consider any change in the policy.

We also believe that the growth forecasts could be revised down in the next policy meeting. For now, the RBI’s estimate stands at 7.2-7.3 per cent for 2H-FY19, which could be revised down to 6.9-7 per cent. Current growth estimate of the RBI is premised on a rise in seasonally adjusted capacity utilization levels. While that certainly ties in with the double digit investment growth numbers in the latest GDP data, there are surprisingly little signs on the ground as far as a revival in the private capex cycle is concerned. Moreover, we believe that the favourable impact of the recent decline in oil prices (on corporate margins) is likely to come in the last quarter and not in the third quarter. Also, there are some early signals that suggest some moderation in rural demand, which could weigh on growth momentum in 2H-FY20. All this, will take place with an adverse base-effect operating in the background. This along with subdued inflation trajectory could make room for change in stance (to ‘neutral’) in February.

Bond market: yields may drop to 7.3%

Broadly, the policy decision was line with our expectations. Given the sharp downward revision in RBI’s inflation forecast, we could see some renewed buying activity in the domestic bond market. We now expect the benchmark 10-year bond yield to drop to 7.3 per cent levels in the short-term against our earlier estimate of 7.5-7.8 per cent. Apart from lower than expected inflation trajectory, there are some more factors that have led us to change our call for the bond yields, vis-à-vis continued OMO purchases from the RBI, gradual return of portfolio investments into the Indian debt market, and more importantly, the inversion of the US yield curve. We now anticipate bond yields to trade in the range of 7.3-7.5 per cent (December-end). There are still some uncertainties on the fiscal front, which could cap the gains to some extent in our view.

Rupee: We do not expect Wednesday’s decision to have a significant impact on the Fx market and stick with our call of 71-73 for the USD/INR pair by December end.

(The author is chief economist at HDFC Bank)