The key takeaway from the new monetary policy statement is that inflation seems to have peaked. The Reserve Bank of India (RBI) has sharply brought down its estimates of inflation for the new fiscal year — especially if one looks past the increase in house rent allowance paid to government employees (as one should). Bond yields have tumbled to their lowest level in nearly four months soon after the policy announcement.
The monetary policy committee has left rates unchanged for now. That was expected. The big question: Will the next move by the Indian central bank be a rate cut?
No central bank statement is unambiguous. The Indian central bank has flagged several reasons why its inflation forecast for the next fiscal year could go wrong — from an increase in farm support prices to higher global oil prices to fiscal slippages in a big election year. Inflation expectations have also inched up. The minutes of the monetary policy committee will make for interesting reading when they are released later this month.
The overwhelming consensus in the Indian financial markets was that interest rates were more likely to be increased rather than reduced over the next few quarters because of incipient inflationary pressures in an economy that is gathering speed. Bank of America Merrill Lynch economists Indranil Sengupta and Aastha Gudwani were among the rare dissenters. Their recent reports have been predicting a rate cut in the August meeting of the monetary policy committee, once there is clarity on the state of the monsoon rains.
The risk from a strategy of cutting rates at a time when US interest rates are hardening is that the rupee can come under pressure at a time when other macroeconomic vulnerabilities are on the horizon. So it will not be an easy call. A lot will thus depend on not just the growth-inflation dynamics in India but also what happens in the rest of the world.