RBI retains inflation focus. RBI expectedly kept policy rates unchanged with concerns on inflation overriding concerns on growth slowdown. The rationale for the status quo was primarily to anchor inflation around the 4% mark while ascertaining the nature of the growth slowdown. We expect headline inflation to inch towards 4.7% by end-March 2018 given the adverse domestic and global conditions. We, thus, expect status quo for rest of FY2018 but will be watchful of incoming data surprises.
RBI maintains status quo
RBI expectedly kept the policy repo rate unchanged at 6%, given the upside risks to inflation even as it acknowledged the widening output gap. Five members voted for a pause and one member voted (Prof. Dholakia) for at least 25 bps cut. The tone of MPC was neutral-hawkish given the adequate concern on the expected uptrend in the headline and core inflation. RBI noted that the retail inflation rose by ~2% since its last meeting, which has coincided with fiscal concerns and heightened geopolitical and global financial volatility. RBI also lowered the Statutory Liquidity Ratio (SLR) by 50 bps from 20.0% to 19.5%, effective October 14, 2017. The ceiling on SLR securities under 'Held to Maturity' (HTM) will also be reduced in a phased manner from 20.25% currently to 20% by December 2017 and to 19.5% by March 2018.
Inflation to trend higher
RBI has revised up its CPI inflation trajectory marginally for 2HFY18 to 4.2-4.6% (including center's 7CPC HRA) from August policy estimate of 4.0-4.5%, with 4.2% in 3QFY18 and 4.6% in 4QFY18. This is in line with our estimate of ~4.7% by March 2018 given (1) adverse base effect, (2) 7CPC HRA implementation, (3) pending changes of GST rates, (4) imported inflation from recent INR depreciation, (5) mean reversion of food prices, (6) higher commodity prices and (7) global financial tightening. The recent excise duty cut in petrol and diesel is expected to lower CPI inflation by ~8 bps through the direct impact, capping some upside. Also, the Monetary Policy Report noted that if GFD/GDP widens by 50 bps in FY2018, inflation could be ~25 bps higher. Further, RBI expects CPI inflation to range 4.5-4.9% in FY2019.
Growth revised lower but RBI remains optimistic in 2HFY18
The weakness in growth did not seem to perturb RBI enough and they remain optimistic of a recovery in 2HFY18. Nonetheless, RBI has revised down the FY2018 real GVA growth projection by 60 bps to 6.7% (Kotak: 6.8%) amid the 1HFY18 slowdown given the lower estimates of Kharif production and GST-linked disruption. However, RBI has acknowledged that they require more data to better ascertain the transient versus sustained headwinds in the recent growth prints.
RBI to stay on hold; incoming data still remains key
Based on our estimated uptrend in inflation trajectory and risks to fiscal slippage, we reiterate our call that the RBI will pause for the rest of FY2018. However, we will be watchful of the incoming data and note that room for any further cut will open up again if inflation surprises meaningfully below RBI's expected trajectory. In this context, we will monitor the evolution of (1) food production, (2) downward surprise of core inflation owing to weaker-than-expected growth, (3) second-round impact of lower excise duty on petrol and diesel and (4) the government's fiscal status.
Snapshot of regulatory policies announced in the RBI policy
- SLR reduction by 50 bps. RBI cut SLR by 50 bps to 19.50% of NDTL, effective October 14, 2017 - as a part of the process of the ongoing transition to LCR regime to 100% by January 2019. The ceiling on SLR securities under HTM will also be reduced from 20.25% to 19.50% of NDTL in a phased manner, i.e. 20.00% by end-December and 19.50% by end-March 2018.
- External benchmarks for effective monetary transmission. RBI will likely review the current base rate/MCLR regime, which seems to not have delivered effective transmission of monetary policy. RBI notes that arbitrariness in calculating the base rate/MCLR and spreads charged over them have undermined the integrity of the interest rate setting process. They will look for a switchover to an external benchmark in a time-bound manner. The base rate/MCLR regime is also not in sync with global practices on pricing of bank loans.
- Improving transparency in state borrowings. Given the high quantum of issuances of SDLs, their auction may become weekly. Besides, states have been encouraged to reissue papers, and issue papers with different tenures, etc. to improve their liquidity and even out redemption pressures and elongate residual maturity. High frequency data relating to finances of state governments will be disclosed for market participants to assess state's fiscal risk metrics.
- Retail participation in primary auctions. Specified stock exchanges, in addition to scheduled banks and primary dealers, will be permitted to act as aggregators/facilitators for retail investor bids in the non-competitive segment for the auction of dated securities and T-bills.
- FPI policies to be reviewed. Keeping in mind macro-prudential considerations, such as ensuring the resilience of net international investment position, a detailed review of current regulations on FPI debt investment shall be undertaken to facilitate the process of investment and hedging by FPIs.
- Operational flexibilities for non-resident importers and exporters. Non-resident importers and exporters (NRIE) entering into rupee invoiced trade transactions with residents will be permitted to hedge their INR exposures through their centralized treasury/group entities. This is expected to facilitate internationalization of the rupee by encouraging rupee invoicing of trade transactions while also encouraging non-residents to hedge INR risks onshore.