MONETARY POLICY

RBI flags risks from trade war, rising crude prices; expect long-pause on rates

rbi-mpc-urjit-reuters The Reserve Bank of India (RBI) Governor Urjit Patel arrives to attend a news conference after a monetary policy review in Mumbai | Reuters

In line with what many expected, the Reserve Bank of India maintained the status quo on interest rates in the first bi-monthly monetary policy of the financial year on Thursday. With inflation trending below its expectations, but as upside risks remain, the central bank is likely to maintain an extended pause this year, while it monitors key data points.

The RBI's benchmark repo rate has been maintained at 6 per cent, ever since it was last cut by 25 basis points in August 2017. With February retail inflation at 4.4 per cent, coming in much lower than its 5.1 per cent forecast for the January-March quarter, there were calls from certain sections to cut interest rates. But, RBI has maintained its “neutral” stance.

“Ongoing normalisation of interest rates in the US, higher global crude oil prices, and the looming threat of escalation in global trade war warranted a cautious approach. The neutral stance is also justified by the government's proposed recalibration of minimum support prices upto 1.5 times the cost of production for the upcoming kharif season,” said Rana Kapoor, MD and CEO of Yes Bank.

The RBI cut its consumer price index (CPI) inflation forecasts sharply, and now expects it to be in the 4.7 per cent to 5.1 per cent range in the first half of the current financial year-ending March 2019, versus 5.1 per cent to 5.6 per cent it had projected in the previous monetary policy announcement.

For the second half of the year, it expects CPI inflation to be around 4.4 per cent, including the impact of higher house rent allowance for central government employees, compared with its earlier forecast of 4.5 per cent to 4.6 per cent.

The central bank sees several factors influencing the inflation outlook.

“International crude oil prices have become volatile with a distinct hardening bias from the second half of March. Indian domestic demand is expected to strengthen during the course of the year. The statistical impact of an increase in HRA for central government employees under the seventh pay commission will continue till mid-2018, and gradually dissipate thereafter,” said Urjit Patel, governor of RBI.

The central bank also expects the GDP (gross domestic product) growth to strengthen to 7.4 per cent in 2018-19, versus 6.6 per cent last fiscal. However, Patel did warn that “while global economic activity and trade have gathered momentum, financial market volatility and potential trade wars pose a threat to the outlook.”

Nevertheless, the central bank is unlikely to change its stance on rates for some time as it continues to track incoming data.

“With inflation estimated to be in a kind of “no-man’s land” (neither too high nor too low), we maintain our call that the RBI will remain on an extended pause,” said Suvodeep Rakshit, senior economist at Kotak Institutional Equities.

He says one must carefully observe the impact of food prices in the near term, risks of fiscal slippages, domestic growth recovery, and evolving global macro conditions (trade wars, monetary policy cycle, and commodity prices) to gauge the RBI’s next move.

“The balance of risks and outlook included in the policy suggests a low likelihood of a change in the repo rate or stance of monetary policy until there is greater clarity on the extent of impact of the MSPs and monsoon on the inflation trajectory, which is unlikely to emerge in the next few months,” said Naresh Takkar, MD and CEO of credit ratings agency ICRA.

In other major announcements by the RBI on Thursday, the implementation of Indian accounting standard (Ind AS) for banks has been deferred by one year. Scheduled commercial banks were earlier expected to implement Ind AS from April 1, 2018.

“Ind AS was to be implemented effective from this year. In our assessment, some of the banks are still not prepared to move into Ind AS. So, we thought that we should defer this by one year,” said N.S. Vishwanathan, deputy governor of RBI.

He also pointed that the format of the financial statement as prescribed in schedule three of banking regulation act is not amenable to reporting financial statements under Ind AS and therefore the RBI has requested the government to amend the schedule and that was under consideration.

However, the central bank will continue to seek the proforma of financial statements from the banks to monitor the progress of banks' preparedness towards migrating to Ind AS, he added.