Dovish surprise

In its first bi-monthly monetary policy statement for FY2018-19, the Reserve Bank of India expectedly kept the policy rates unchanged. However, the policy did throw up one surprise — on the dovish inflation trajectory expected in FY 2018-19.

While the market expected a status quo on Repo rates, there was also expectation of a neutral to slightly hawkish tone. However, markets were taken by complete surprise on inflation projections resulting in a big rally in the bond markets.

Global economic activity gathered momentum across advanced and emerging economies. Inflation and rates estimation were lower leading to a less hawkish policy from the Federal Reserve. The policy expectation is that global growth is likely to sustain momentum this year.

In the domestic market, high frequency indicators show a strengthening of demand, consumption and growth prospects. Thus, across urban and rural markets, consumption seems to be on a firmer trend albeit with weaker exports. There was an acceleration in services as well. Thus, GDP growth for FY18-19 is projected to be higher at 7.4 per cent from 6.6 per cent in FY17-18.

The MPC struck an unexpected dovish tone on the inflation trajectory in FY2018-19. Retail Inflation, measured by CPI, fell from 5.1 per cent in January 2018 to 4.4 per cent in February 2018, due to significant contraction in food and fuel prices.

Excluding food and fuel, CPI remained unchanged at 5.2 per cent for the third consecutive month in February. The central bank expects the lower inflation trajectory to continue and revised inflation projections in the first half to a range of 4.7 to 5.1 – from a range of 5.1 to 5.6 in the last policy.

Inflation in the second half is expected at 4.4 per cent. This is 10 bps lower than estimates in the previous policy. This is likely to keep policy rates unchanged for an extended period. The MPC, however, also took note of some uncertainties and outlined upside pressures to inflation from volatile crude prices, higher minimum support prices for crops, impact of HRA revisions, fiscal slippages at the Centre and States and strengthening domestic demand. Uncertainty around the monsoons could also impact near-term inflation.

From a macro perspective, strong consumption and growth trends, lower inflation, lower government borrowings, higher upfront spending by the government and increased credit offtake, point to a positive, stable and conducive environment for investment and growth.

Inflation risks

Overall, the policy which was expected to be a non-event, surprised on the positive side largely because of a change in inflation estimates for FY 2018-19. This will keep interest rates unchanged for a long time aiding growth. Bond markets saluted the policy with a big rally and we will see this spill over to the real economy and markets.

Challenges do remain. There are upside risks to inflation. In addition, efforts on deleveraging distressed corporates and rebuilding bank balance sheets continues. With the Indian economy in the midst of a nascent recovery, the RBI will continue to tread carefully as it keeps one eye on inflation and focuses on providing a stable environment for growth. Further policy action will be determined by the inflation and growth trajectory over the next many months, though going by today’s policy statement, we expect an extended pause.

The writer is President-Consumer Banking, Kotak Mahindra Bank