With the Reserve Bank of India’s Monetary Policy Committee now focussing on meeting the medium-term inflation target of 4 per cent, the rate-cutting cycle seems to be over and policy rates are likely to remain unchanged in 2017, bankers said.
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The MPC, according to RBI minutes, has listed three upside risks that impart some uncertainty to the baseline inflation path — the hardening profile of global crude prices; volatility in the exchange rate, which could impart upside pressures to domestic inflation; and the effects of the house rent allowances under the 7th Central Pay Commission which have not been factored in the baseline inflation path.
According to Nomura, the rate-cutting cycle has come to an end because growth should gradually bounce back as the economy is remonetised. “We expect inflation to inch towards 5.5-6.0 per cent in H2 FY18 (above RBI’s projection of 4.5-5.0 per cent) owing to the firming up of rural wages, higher minimum support prices and gradual narrowing of the output gap. We expect rates to stay on hold throughout 2017,” it said.
Kotak Securities said in a report: “The minutes reaffirm our view that the RBI will stay on an extended pause for now. The unanimous view seems to be of risks from high and sticky core inflation, uncertainty from international factors and upside risks to inflation…”
The minutes reveal that all MPC members grew more confident that as the economy is remonetised, the segments hit by demonetisation will see growth bouncing back. “Along with lower lending rates, better global growth and a prudent budget, prospects for growth in FY18 look bright. The current drop in inflation is largely viewed as transitory, driven by fire sales in vegetables (post demonetisation). As the economy is remonetised, most MPC members believe there is a risk of a sharp rebound in vegetable prices. Sticky core inflation, higher international commodity prices, higher rural wages and the seventh pay commission allowance rise — the latter two were mentioned by RBI governor Urjit Patel — are seen as risks to the medium-term target of 4 per cent,” Nomura said.
Four out of six MPC members highlighted that it was time to focus on the medium-term inflation target to ensure a calibrated approach that minimises the cost and ensures sustainability.
Bankers said it is this backdrop that prompted a shift in the policy stance to neutral from accommodative. The MPC believes that a neutral stance gives it the required flexibility to react (in any direction) to bring inflation closer to 4 per cent, they said.
Bank of America Merrill Lynch said: “We expect bank lending rates to come off by 50-75 bps in the April-September ‘slack’ industrial season with Governor Patel stressing the need for lower borrowing costs. Banks have already cut MCLR after the PM’s December 31 speech. We assess that the RBI has to OMO Rs 220,000 crore (of which the Budget committed Rs 75,000 crore of buyback) to push liquidity in the money market into neutral by March 2018.”
According to the MPC, the persistence of inflation excluding food and fuel could set a floor on further downward movements in headline inflation and trigger second-order effects. “Headline CPI inflation in Q4 FY17 is likely to be below 5 per cent. Favourable base effects and lagged effects of demand compression may mute headline inflation in Q1FY18. Thereafter, it is expected to pick up momentum, especially as growth picks up and the output gap narrows,” the MPC said.