INSUBCONTINENT EXCLUSIVE:
By Suvodeep RakshitAs the RBI MPC goes into the June policy meeting, the nub will be choosing between maintaining a wait-and-watch strategy
and being pre-emptive about incipient adverse risks to inflation
While we expect the RBI MPC to hold the repo rate in June, we pencil in 50 bps hike in FY19 split between August and October
The MPC votes are likely to be evenly balanced in the June meeting, thereby keeping the chances of a rate hike alive
While adverse risks of a higher crude price and a weaker rupee are at play, higher than usual MSP increases are a key unknown risk, for now
If MSP increases are in line with recent trends, the RBI can still have some space to maintain status quo, keeping in view the need to
balance emerging price pressures with a nascent cyclical economic recovery.
The RBI will have four key issues to contend with as it goes
into the policy rate decision.
Worsening CPI inflation outlook: Inflation uncertainty appears to have increased over the past few months
We expect FY19 CPI inflation to average 4.7 per cent as against 3.6 per cent in FY18
More importantly, we are cautious of the imminent MSP increases -- which if implemented as outlined in the Budget could impact prices by
However, upside risks will be capped if MSP increases turn out to be not materially different from the recent trends
and risks from MSP hikes, the consistent increase in core inflation -- running significantly higher than the headline -- is ominous
The spike in core inflation to 6 per cent in April led by a broad-based sequential increase in sub-categories has strengthened our fears
that core inflation may be getting entrenched
Amid a narrowing output gap, rising input costs will likely be passed on to consumers, leading to higher retail inflation.
While some of the
the same even without it.
Sharper-than-expected crude price movement: While prices have corrected of late on the back of a possible supply
increase by Russia and Saudi Arabia, the levels remain much higher than what has been the trend over the last few months
Coupled with rupee depreciation as well as unchanged excise duties, the crude price movement has indeed put sustained upward pressure on the
For the RBI, impact on headline CPI inflation may not be too large, but certainly would be a concern on inflation expectations getting
was at $78.
Persistent rupee weakness: The recent rupee weakness (down around 3.5 per cent against the dollar in FYTD19) may further prod
the RBI to tighten its stance, taking cues from some EM central banks such as Turkey and Indonesia.
However, the impact of a shallow rate
hike cycle on the rupee may be limited, given that FPI flows in India may remain at risk from domestic and global factors
However, it will be interesting to see if the RBI sees real risk of the rupee depreciation feeding into CPI inflation.
Our call for a pause
in June is predicated on the RBI likely preferring to get some clarity on (1) extent of MSP increases, and (2) how the crude prices and
rupee evolve over the next 1-2 months
The next US FOMC decision is on June 13
If risks pan out as expected, the August policy could see the first rate hike after over three and a half years.
The RBI will also be
mindful of the liquidity situation and how the financial conditions have tightened even without the policy rates actually having been
These obviously will keep the RBI MPC on the edge in an adverse macroeconomic scenario
The bond market dynamics are, however, unlikely to change much with a shallow rate hike cycle.
(Suvodeep Rakshit is Vice-President and
Senior Economist at Kotak Institutional Equities
