We expect a final rate hike of 25 bps towards the end of FY19: Aditi Nayar

Principal Economist, ICRA

With concerns related to various inflationary risks amid narrowing of the output gap, the Monetary Policy Committee (MPC) voted 5:1 to hike the policy repo rate by 25 bps to 6.5 percent in the August 2018 policy review, as anticipated.

At the same time, it retained the neutral stance of monetary policy, which suggests that the future rate action would remain data dependent. This helped to cool bond yields by around 8 bps, as the rate hike itself was already priced in.

The headline and core (excluding food and beverages and fuel and light) CPI inflation had risen to a five-month high 5 percent and a 47-month high 6.4 percent, respectively, in June 2018.

The MPC highlighted various risks to the inflation trajectory, which include global factors, such as the volatility in prices of various commodities and in global financial markets.

Domestic concerns include rising inflationary expectations of households, the unfavourable distribution of the monsoon so far, and the likely impact of revised minimum support prices (MSPs) on the prices of food items.

Moreover, the committee highlighted concerns regarding the impact of potential fiscal slippage at the central and state government level on market volatility, crowding out of private investment and the inflation trajectory.

The Committee highlighted that the output gap has virtually closed, amid healthy industrial and service sector activity, capacity utilisation, and business sentiment. The progress of the monsoon and the revision in kharif MSPs should support rural demand going ahead.

Despite some tightening of financing conditions, rising FDI flows and favourable domestic capital markets portend a healthy outlook for investment activity.

At the same time, the MPC emphasised concerns emanating from the impact of rising trade tensions on Indian exports, and the broader risks related to the effect of geopolitical tensions and higher crude oil prices on global growth.

The MPC retained its GDP growth projection for FY19 at 7.4 percent, while expecting GDP growth to rise to 7.5 percent in Q1 FY2020. Moreover, it modified its inflation projections to 4.6 percent for Q2 FY2019 and 4.8 percent for H2 FY2019 and placed its forecast at 5 percent for Q1 FY2020.

Notwithstanding the neutral stance, a final rate hike of 25 bps towards the end of FY2019 should not be ruled out, given that the MPC’s inflation projection for Q1 FY2020 of 5 percent, is well above the medium-term target of 4 percent.