Two months ago when the Reserve Bank of India (RBI) kept the policy rates unchanged on October 4, analysts were expecting a rate cut in the December 6 policy review. However, with rising inflation and worries over the fiscal deficit, expectations are now on the central bank opting for status quo or leaving key policy rates unchanged. In fact analysts have now started talking about a rate tightening cycle ahead as inflation is expected to inch up in the coming weeks.
“We had expected one last 25 basis points rate cut from the MPC in February 2018 before a prolonged pause. However, with global crude oil prices hovering at $63 per barrel and Centre likely to miss its FY18 fiscal deficit by 30 bps, we believe a rate cut in FY18 now looks difficult,” said Tanvee Gupta Jain, economist, UBS Securities India. The RBI last cut the repo rate by 25 bps to 6 per cent in the August 2017 review. It has cut repo rate by 200 basis points since January 2014, but transmission of the cut has been very slow with banks effecting steeper deposit rate cut while going slow in the lending rate reduction.
Rating agency ICRA anticipates that the MPC would leave the repo rate unchanged at 6 per cent in a non-unanimous decision in the December 2017 policy review, given the expectation of a further rise in the CPI inflation in the coming months. With GVA (gross value added) growth estimated by the Central Statistics Office (CSO) at 5.8 per cent in the first half of FY18, a downward bias is likely to be placed on the MPC’s baseline forecast for growth of gross value added (GVA) at basic prices of 6.7 per cent for FY18.
“Although the CPI inflation for October 2017 was lower than the range of 4.2-4.6 per cent for the second half of FY18 that the MPC had forecast in its 4th policy review for FY18, and the recent revision in GST rates would ease price pressures, certain inflation risks persist. With the CPI inflation likely to track a rising trend over second half of FY18 and print at around 4.5 per cent in March 2018, we expect an extended pause amid non-unanimous voting by the MPC in the December 2017 policy review,” said Naresh Takkar, MD and group CEO, ICRA.
Stock markets have already raised the red flag over the rising fiscal deficit and worried investors unloaded stocks last week, sending the Sensex plummeting by close to 770 points in the last two sessions. India’s fiscal deficit at the end of October hit 96.1 per cent of the budget estimate (BE) for fiscal 2017-18, mainly due to lower revenue realisation and rise in expenditure. “We see the risk of combined fiscal deficit widening to 6.5 per cent of GDP in FY18 compared with the government’s BE of 5.8 per cent. We believe Centre will likely breach its FY18 target of 3.2 per cent of GDP by 30 bps, mostly due to lower revenue collection rather than higher expenditure,” Jain said.
Economists say that policy rates are likely to remain unchanged in FY18. “Data also suggests that while lower GST rates have moderated output prices, input cost pressures are marginally higher, which along with higher food inflation is likely to push CPI inflation slightly above the RBI midpoint target of 4 per cent in November and beyond. We expect a hawkish hold from the RBI next week (December 6) and policy rates to remain unchanged through 2018,” said Sonal Varma, economist, Nomura.
Will the central bank raise rates? It’s unlikely to happen so soon as a rate hike in the current environment would derail the growth recovery. India is still in the midst of a recovery cycle, with private investment remaining weak and subdued credit growth reflecting sluggish economic activity. The current policy initiatives like PSU banks recapitalisation should help create a supportive environment for growth and create willingness to extend credit on the part of banks as and when investment demand recovers. “India is moving from goldilocks economy (low growth low inflation) to crack-up boom (high growth but higher inflation)… whereas goldilocks is good for every asset (fixed income, equities, even real estate), crack-up boom is good only for equities and hence we are finding bond yields rising but equities are also resilient,” said Ritesh Jain, Chief Investment Officer, BNP Paribas.
The year-on-year (YoY) CPI inflation hardened to a seven-month high 3.6 per cent in October 2017 from 3.3 per cent in September 2017, even as the core-CPI inflation (excluding food and beverages and fuel and light) remained steady at 4.6 per cent in October 2017, in line with the print in September 2017.