Looking past the RBI's status quo: Are there signs the rate cut cycle is ending?

Another bone of contention between the RBI and the government has been the latter's suggestion to start a payments regulator outside the purview of the RBI. (Image: Reuters)

The status quo on rates was the least of the surprises from the MPC (monetary policy committee) meeting of Reserve Bank of India (RBI) today. Perhaps what was loud and clear was the RBI’s stance on future rates – at least in the foreseeable future, there is no possibility of a rate cut; depending on the inflation trajectory, one shouldn’t be surprised if the next move is a rate increase.

On expected lines, the RBI kept the repo rate, reverse repo rate and bank rate unchanged at 6.0 per cent, 5.75 per cent and 6.25 per cent, respectively.

While keeping the medium-term target for consumer price index (CPI) inflation of 4 percent within a band of +/- 2 percent, the central bank raised the near-term forecast of inflation to 4.3-4.7 percent for the second half of FY18 from the October policy’s forecast of 4.2-4.6 percent. This is the second revision of this estimate.

While drawing comfort from the likely seasonal moderation in vegetable prices in winter, falling prices of pulses and the downward bias on prices due to recent reduction in GST rates on several items, the RBI remained hawkish due to impact of:

• Increase in house rent allowance (HRA) by the Centre, which is expected to peak in December
• Staggered impact of HRA increases by various state governments
• Rise in international crude oil prices that may sustain due to OPEC’s decision to maintain production cuts
• Inflation expectations of households surveyed by RBI, which have firmed up; any increase in food and fuel prices may further harden these expectations
• Rising input cost conditions pointing towards higher risk of pass-through to retail prices in the near term
• Implementation of farm loan waivers, partial roll back of excise duty and VAT, and decrease in revenue on account of reduction in GST rates that may result in fiscal slippage with attendant implications for inflation
• Global financial instability on account of interest rate normalisation and fiscal expansion also carrying risks for inflation

While the RBI sounded less than excited about the Q2 FY18 GDP print, it nevertheless maintained the full year GVA (gross value added) target for FY18 at 6.7 percent. It expects GVA for the coming to quarters to revive to 7 percent and 7.8 percent, respectively.

The central bank nevertheless drew attention to several early green shoots on growth:

• RBI’s Industrial Outlook Survey expects production to pick up in Q3 as order books are rising.
• There has been some pick-up in credit growth in recent months (from 6.8 percent at the time of October policy to 8.6 percent now).
• Recapitalisation of public sector banks may help improve credit flows.
• RBI survey indicates that the services and infrastructure sectors are expecting an improvement in demand.
• Several companies have raised capital from primary market and are likely to deploy the same in setting up new projects that will impact medium to long term demand
• Improvement in the ease of doing business ranking should help sustain foreign direct investment

In sum, while maintaining the overall neutral stance, the tad bullishness on growth and hawkishness on inflation clearly points to an end of the rate cut cycle. Should markets start monitoring the data points for the first rate hike of a new cycle?

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