The Monetary Policy Committee (MPC) of the Reserve Bank of India today kept its policy rates unchanged, with repo rate at 6%, the reverse repo rate at 5.75%, and marginal standing facility rate at 6.25%. Five out of six members of the committee were in favour of the decision, while one voted for a 25 basis points (bps) cut.
The MPC maintained its neutral monetary policy stance, but remains concerned on the inflation trajectory given the recent rapid rise in inflation (excluding fuel and food). For the first five months of fiscal 2018, consumer price inflation (CPI) averaged 2.5%. The MPC expects the second half of fiscal 2018 to see CPI average 4.3-4.6% after including the impact of house rent allowance promised by the Centre. The MPC reiterated its focus to maintain medium-term inflation at 4%.
The MPC sharply cut its gross value added (GVA) growth forecast to 6.7% from 7.3% estimated earlier taking cue from a sharper-than-expected slide in growth in the first quarter of fiscal 2018 and initial hiccups faced by the manufacturing sector due to goods and services tax (GST) implementation.
The MPC’s stance is in line with our expectation. To be sure, there are concerns with GDP growth sliding down to a thirteen-quarter low of 5.7% in the first quarter of fiscal 2018. But a large part of the slowdown is expected to be transitory, led by waning impact of demonetisation and initial hiccups because of the implementation of GST. Though this does bring down our full-year GDP growth estimate to 7% (from 7.4% earlier, and also below the fiscal 2017 estimate of 7.1%), the economy will grind up over the next few quarters as the impact of demonetisation and destocking due to GST implementation wears off.
Preliminary signs of bottoming out in some sectors are visible -- auto sales have started picking up in July and August led by passenger and commercial vehicles, while core infrastructure sector data shows that on-year production growth so far in the second quarter is higher than in the previous quarter.
Meanwhile, although inflation remains within the 4% band, its steady rise has led the MPC to flag concerns. Waning of low-base effect, some bump up in oil prices, and the possible impact of GST have led to a rapid rise in the consumer price index (CPI)-based inflation. In August, CPI inflation jumped to 3.4% from 2.4% in July. More importantly, despite the dent in demand due to recent disruptions, core inflation (which excluded food, fuel, light, petrol and diesel) has stayed quite sticky. Core inflation fell just 120 bps from its peak in June 2016 to 3.9% in June 2017, whereas overall inflation fell 460 bps during that period. Core inflation has now climbed up to 4.4%.
Going ahead, if the risks to growth rise, and inflation undershoots the MPC’s forecast, then there is a possibility of a rate cut. The second-quarter GDP data will be a key deciding factor. If growth sulks down further, it can potentially bring down core inflation, too. A dip in core can provide a faster downside to overall inflation. Meanwhile, reasonably healthy food production aided by good monsoon will keep food inflation low, too.