Aditi Nayar ICRA
The Monetary Policy Committee (MPC) had voted 5:1 to maintain the repo rate at 6.50 percent in the October 2018 policy review, after having hiked rates twice in the previous two policy reviews. However, it had changed the stance of monetary policy from neutral to calibrated tightening, which had suggested a continuing likelihood of future rate hikes.
This expectation has been belied by subsequent data. With sub-4 percent CPI inflation for three consecutive months, a sharp correction in crude oil prices and the strengthening of the rupee, the repo rate appears unlikely to be changed in the upcoming policy review.
Although the CPI inflation in Q3 FY19 is likely to lag the MPC's estimate, a rate cut is ruled out given the change in stance to calibrated tightening and the high core-CPI inflation print for October 2018.
Following the year-on-year (YoY) disinflation in retail food prices in October, the outlook for food inflation remains somewhat mixed. Market prices of various crops are trending well below the revised minimum support prices, easing concerns about the inflationary impact of the latter while casting doubt on the sustainability of rural demand going ahead.
Following the late withdrawal of the monsoon rains, the sharp deficit in post-monsoon rainfall has led to a decline in reservoir storage levels and a delay in rabi sowing, which may create price pressures over the next few quarters.
Additionally, inflation risks related to fiscal factors, such as the staggered pay revision by some state governments and expenditure announcements by the central and various state governments, cannot be ruled out.
Geopolitical developments and supply-demand balances would continue to influence crude oil prices, and consequently, the sentiment toward the rupee and the domestic inflation outlook. We do not expect a sharp rebound in crude oil prices or a re-testing of the all-time low by the rupee in the second half of FY19, which should ease inflationary concerns.
On balance, the CPI inflation in FY19 is likely to average 4.2 percent, only mildly higher than the MPC's medium-term target of 4 percent. Therefore, the likelihood of a rate hike in the February 2019 policy review appears subdued, in ICRA’s view.
The expectation of status quo on the policy rate, the announcement of a pipeline of OMO purchases by the central bank in December 2018, and the correction in crude oil prices would keep a check on G-sec yields in the immediate term, despite continuing concerns of a potential fiscal slippage relative to the budgeted target for the central government in FY19.
Disclaimer: The author is Principal Economist at ICRA. The views and investment tips expressed by investment expert on moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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