DBS Economics: Indian policy rates maintain a steady course

Ms. Radhika Rao, India Economist, DBS Bank

In its first policy review for FY19, the Reserve Bank of India (RBI) kept the benchmark rates unchanged on Thursday - repo rate at 6% and reverse repo rate at 5.75%. The 5-1 split vote saw the dissenting member, Michael Patra, vote for a 25bp hike. Official guidance was neutral, against expectations for a shift to a moderately hawkish stance. In a surprising move, the central bank took a very dovish view on the inflation path for the year.

Economic assessment: The RBI lowered the inflation forecasts, but expressed more conviction that GDP growth had bottomed out and is likely to gain momentum this year. Projected CPI inflation for H1 FY19 was revised to 4.7-5.1% (vs 5.1-5.6% earlier) and H2 to 4.4% (vs 4.5-4.6% prev). Excluding the impact of the housing rent allowance, the inflation path is seen at a more modest H1's 4.4-4.7% and 4.4% in H2.

On inflation, the June to December 2018 quarters are likely to distorted by statistical factors - base effects and fading impact of one-off catalysts same time last year, with a true underlying inflation likely to emerge into 2019. We expect inflation to remain above target this year, but not test past the higher band i.e. 5% mark in a sustained fashion.

Despite the downward revisions to inflation, the RBI retained the upside risks highlighted in the February review: a) minimum support price increases; b) staggered impact of housing rent allowances by states; c) widening consolidated fiscal deficits; d) monsoon progress; e) indications that of an increase in input and output prices, per the Reserve Bank's Industrial Outlook Survey, and; f) volatility in crude prices.

On growth, the RBI shifted to projecting real GDP instead of the GVA measures (Gross Value-Added), citing the need to align with international practises. It expects real GDP to strengthen from 6.6% in FY18 to 7.4% in FY19 - both left unchanged since the last review.

RBI tempers hawkish hues

The RBI's decision to lower its full-year FY19 inflation forecasts was a surprising move, suggesting no imminent rate hike risks. Policymakers are, nonetheless, likely to stay glued to upcoming developments. The impact of minimum support price hikes (details are likely in May/ June) and the recent jump in domestic fuel prices, on inflationary expectations will be under close watch. Severity of the inflationary impact also hinges on rural wage growth and procurement. While upside on inflation and price expectations are forthcoming, we reckon that the MSP-driven lift might be less severe than the popular narrative suggests.

We retain our call for the benchmark rates to be left unchanged in 2018. If MSP increases are accompanied by sticky inflation beyond June/July, compounded by high oil prices and heightened market volatility (INR weakness), the RBI might revisit tightening risks, but odds are low at this juncture.

Equity and bond markets cheered the RBI's move to temper its hawkish talk. Apart from the RBI policy, bonds are likely to trade with a positive bias in the short-term, in view of few other catalysts: i) imminent roll out of the new FPI (Foreign Portfolio Investors) framework, which is expected to augment demand for the bonds; ii) softer UST yields. We remain skeptical on the sustainability of this bond rally in H2 when the supply pipeline will get busier and concerns over fiscal run-rate and crowding out risks resurface.

Source : Equity Bulls

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