Monetary policy review: RBI's dovish tone divides economists

Reserve Bank of India
The Reserve Bank of India’s (RBI’s) dovish language in the first bi-monthly monetary policy in 2018-19 has upset the projections of many economists who were expecting interest rates to harden sometime this year. Now the consensus is that it would be a prolonged pause, possibly longer than expected. However, some have started giving bold calls for rate cuts, which could happen as early as August, when the RBI meets for the third bi-monthly monetary policy review.

In its policy statement, the RBI revised its inflation forecast for 2018-19 to 4.7-5.1 per cent in the first half of 2018-19 and 4.4 per cent in the second half, factoring in house rent allowance (HRA) for central government employees. The earlier projection was 5.1-5.6 per cent in the first half and 4.5-4.6 per cent in the second, taking into account the HRA impact. The RBI mentioned uncertain risks, including a new method of calculating minimum support prices for kharif crops, a rise in crude oil prices, and fiscal slippages. However, according to economists, the concerns may not turn out to be a reality.

“We assess that the RBI's inflation risks are overdone, given weak growth, tight liquidity, and prospects of normal rains,” wrote Indranil Sen Gupta, chief economist, Bank of America Merrill Lynch. “We grow more confident of our call for a 25-basis point August 1 rate cut call after the RBI MPC expectedly continued with its balanced tone,” wrote Sen Gupta. 

Soumya Kanti Ghosh, group chief economist of State Bank of India, also expects a rate cut. “With market prices lower than MSP, it is unlikely that an MSP boost will fuel inflation,” said Ghosh.

For many other economists, the sharp downward revision came as a surprise and some even say it is a brief halt before the RBI returns to its hawkish stance.

“Overall, we believe that once the transient softening in domestic inflation wanes the RBI might recalibrate its inflation projections, thereby reinstating its earlier hawkish view,” said Dhananjay Sinha, economist at Emkay Global Financial Services. He expects a rate hike. 

Abheek Barua, chief economist, HDFC Bank, wrote: “… whether this is a transient bout of ‘dovishness’ or whether it will endure (especially if one of risks were to surface) remains the key question.” 

Most economists, however, see the RBI maintaining a data-dependent extended pause. “We think the central bank will try to stay on the sidelines as long as possible if the upside risks do not materialise,” wrote Kaushik Das, chief economist of Deutsche Bank India.

“Given the current and near-term growth-inflation mix, we expect the RBI to remain on an extended pause under the baseline scenario of a normal monsoon and global oil prices remaining below USD70/barrel,” Das said.

HSBC wrote in its report: “We have been calling for a prolonged pause for the last few months. Today's policy strengthens our conviction that rates will remain on hold.”

“Given that the monetary policy committee endeavours to maintain inflation near the target of 4 per cent on a durable basis, this revision point towards continuation of a prolonged pause while maintaining caution,” wrote IndusInd Bank’s chief economist Gaurav Kapur.

However, not all are convinced that RBI will not hike rates this year.

“We continue to expect that the central bank will move to hike rates by 4Q18 (December quarter),” wrote Morgan Stanley in a report.

“While inflation is expected to rise in the June quarter, this will be largely driven by base effects in food prices; hence, the MPC's assessment of the inflation trajectory for the second half of fiscal year 2019 will be key in determining its response,” Morgan Stanley said.

BNP Paribas was an outlier. It expects aggressive rate hikes in this calendar year itself.

“Given the upside risks to inflation, we continue to forecast two 25 basis point rate hikes in 2H 2018, to 6.50%. By then, the strength of the economic recovery should give the RBI the confidence to tighten policy,” wrote Su Sian LIM of BNP Paribas.

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