By Anis Chakravarty and Umang Aggarwal
Ever since the “status quo” was maintained in the last monetary policy committee (MPC) meeting, significant changes have been observed in the domestic and the international environment. Global economic activity has continued to gain momentum, especially across US and Europe, with unemployment marking gradual deductions.
Domestically, there have been reasons for hope—healthier production prints and significant improvement in manufacturing growth have been observed, especially in case of capital goods, which has experienced a robust rise. Inflation numbers are still expected to breach the RBI’s 4% medium-term target in 2018, despite having eased slightly over the last month.
The larger than expected softening in recent months follows a slowdown in the more volatile food price inflation, likely caused by one-off seasonal factors. However, the overall mark-up on inflation, on average, remains high, as anticipated. As such, we believe that inflation in the 2018-19 financial year (FY) is expected to hover around the 5%(+) mark with projected risks from fiscal slippage, higher input costs and MSP hikes. The RBI’s own projection on inflation remain high in the 5.1-5.6% range for the first half of the 2018-19 FY, before easing to around 4.5% in the latter part of the year.
Going forward, more clarity must be gleaned from the available data, as positive shoots in the statistics possibly remain affected by favourable base impacts, and to some degree may be a result of restocking. In the future, a relatively higher base is expected to cushion higher inflationary readings, and as such we believe that the RBI is likely to assess such statistical effects while making monetary policy adjustments. Having said that, we believe that in April, monetary policy will see no change in interest rate movement. The projected easing in inflation in the second half of the coming fiscal should prompt the MPC to stay on hold. Furthermore, the 10-year yield has remained at elevated levels and risks of a larger fiscal deficit may dissuade from a rate hike, at least until the market corrects itself.
Therefore, given the outlook on crude oil prices and domestic inflation risks, the MPC is likely to take a more hawkish stance in the months to come. Rising crude oil prices following further output cuts is expected to remain a key inflationary risk, while the incoming signals of further policy tightening in the US should impact domestic policy decisions as well. We would like to reiterate that risks on monetary policy are tilted upward and an interest rate hike may come through toward the end of the year.
Anis Chakravarty is the lead economist and partner at Deloitte India, where Umang Aggarwal is an economist.