RBI extends its pause stance

The Reserve Bank of India (RBI) left the Repo and reverse repo rate unchanged at 6.75% and 5.75% respectively on Tuesday. While the commentary offered little surprises, the tone was more balanced as the central bank is concerned over the evolving inflation outlook (especially pay commission impact) and structural reform (including fiscal discipline). 

The CPI inflation estimate for Mar17 marginally raised to 5% from 4.8% earlier, without factoring in the pay commission increases. The central bank also added that while part of the bounce in inflation (one-off adjustment in the housing index) on the higher wage bill can be overlooked, but generalised pressures due to stronger demand could disrupt the disinflationary trend. Sticky service sector inflation also received a mention. GDP estimate for FY16/17 was held at 7.4% with downside risks and rising to 7.6% in FY16/17. 

RBI also emphasised on the need for structural reforms to contain supply-side pressures and fiscal discipline to ensure that the monetary policy could assume a growth-supportive role. Into FY16/17, with fading incremental boost from low crude prices, the fiscal backdrop is a lot more challenging. The upcoming Budget faces a tough choice between fresh spending commitments, a need to maintain capital expenditure and compensate for low tax buoyancy/ divestment proceeds. 

"We see risks that the deficit target is adjusted modestly higher", notes DBS Group Research.

Policymakers interpreted the on-going tighter conditions as temporary/seasonal rather than structural, keeping reserve ratios unchanged. The RBI highlighted than base money growth had quickened to 12% this year from 10.5% year before, even as nominal GDP growth has been slowing. This suggests sufficient base money is being created, highlighting the need to overlook short-term shortages. The firm 10Y yields were seen as not only a reflection of inflation concerns domestically but also elevated yields amongst the emerging market peers in light of external volatility. 

"We maintain our call that a 25bp rate cut at the Mar/Apr policy review, contingent on the Budget contents", added DBS Group Research.

A move in March will be an inter- meeting cut. The emphasis will also be on jumpstarting transmission to ensure that the policy changes have the desired impact on the ground and for supporting private sector activity.