The market and monetory policy

The monetary policy announced by the RBI during the week, started off with the consensus on status quo being maintained on repo rates. However, the real important take-away from the policy was not just the rate decision but the rate commentary. In fact, the MPC commentary becomes a lot more critical as the big question was not about rate cuts but about rate hikes. Here is what the policy undertone was all about…

Get ready for higher inflation…

The monetary policy has clearly pointed at higher consumer inflation as the big risk for the Indian economy in the next few months. The higher MSP (at 1.5 times the cost of production) is likely to keep food prices higher putting upward pressure on CPI inflation. In fact, the monetary policy has assumed inflation at above 5.1% in the first half with some tapering of inflation in the second half of the current year. That means the average inflation in conservative terms is likely to be above the comfort level of 4% for the RBI. Then there is the bigger risk of higher crude oil prices if the US shale is not able to keep pace with the growth in crude oil demand. Remember, higher oil price has strong downstream effects and that is likely to sharpen the impact on retail inflation, both core and non-core. With inflation likely to remain at elevated levels, the debate is likely to shift more towards rate hikes rather than towards rate cuts. That is the big take-away from the monetary policy!

GDP Growth could be a driver…

The RBI policy has guided a full year GDP growth of 6.6% for the current fiscal with GDP growth in the range of 7.0-7.5% in the coming fiscal. The return to growth is likely to happen with higher inflation accompanying it. The agri sector could benefit from the positive MSP announcements while the industrial sector is already seeing signs of a revival in growth and a turnaround in the capital investment cycle. All this is indicative of higher growth potential in the coming quarters and a much higher rate of inflation that can be sustained in this period.Normally, a return to growth is accompanied by a return to inflation.

Finally,the flows story…

The big story from the RBI monetary policy is that the central bank will endeavor to maintain the rate gap in its benchmark rates to ensure that capital flows into India are not negatively impacted. If the US Fed is going to hike rates by 100 basis points this year, as is likely from data flows, then RBI may be compelled to also hike rates by around 50 bps to ensure that the risk-adjusted gap in benchmark yields is maintained. India saw the impact of debt outflows back in 2013 and would not want to repeat that situation. The RBI has almost cautioned the debt markets to be prepared for rate hikes during the year. Rate hikes may be coming sooner rather than later during 2018!

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