RBI may take a more balanced stance in June

The Reserve Bank of India (RBI) will likely keep the key policy rates unchanged in June and might maintain its “neutral” monetary policy stance. While a neutral policy stance does not preclude the RBI from changing the repo rate in either direction, the bias of the Monetary Policy Committee (MPC) seems to be to keep rates on hold in the near-term, given their explicit change in monetary policy stance as late as in February. However, the MPC is expected to adopt a more balanced rhetoric in June compared to their hitherto markedly cautious tone in 2017.

India’s domestic macroeconomic backdrop clearly remains appropriate for a more balanced tone at present. The latest Consumer Price Index (CPI) inflation stands at three per cent and can move even lower in the near-term. Core CPI has softened materially to less than 4.5 per cent. Expectations of a near normal monsoon, a stronger rupee, broadly stable commodity prices, and a likely less inflationary goods and services tax (GST) should help CPI inflation staying in check, potentially averaging in a 4 per cent-handle during 2017.

India’s external sector dynamics remains healthy with a narrow current account gap (at sub-1 per cent of GDP) and net foreign direct investment (FDI) inflows being about double of that. Foreign institutional investor (FII) inflows have also been strong into both bonds and equities in the recent past, particularly since the ruling BJP’s strong show in state and local elections in February-March. Overall, the recent rupee strength, which has tightened the monetary conditions of late, has several contributing factors and is unlikely to witness any major reversal quickly.

The RBI’s surprise change in monetary policy stance to “neutral” in February was possibly influenced heavily by global concerns, even though the central bank did not mention it explicitly. Indeed, in early 2017, rupee was weakening amid, among other things, upside risks to commodity prices, fears of a hawkish Fed and a further stronger dollar. Such risks seem to have moderated materially since then, while India's real policy rate (ex post) kept climbing higher to over 300 basis points. 

The MPC's fears of a sharp uptick in CPI inflation during the remonetisation phase remained far from being realised, partly indicating weak pricing power in the economy and weak demand side pressure on inflation. 

Market participants must appreciate that staying cautious is a virtue for central bankers and should not expect a sudden reversal in the formal monetary policy stance. On the other hand, the MPC will likely boost its long term credibility by coming out with the most objective assessment of the economy rather than trying to defend any previously adopted stance.