The repo rate debate
Sonal Varma

Policy action: The Reserve Bank of India’s (RBI) monetary policy committee (MPC) voted 5-1 in favour of leaving the policy repo rate unchanged at 6 per cent, in line with consensus and our expectations. The one dissenting member, Ravindra Dholakia, voted for a 25bp cut. The RBI also lowered the statutory liquidity ratio (SLR) by 50bp from 20 per cent to 19.5 per cent, effective from October 14. The ceiling on SLR securities under “held to maturity” (HTM) will also be reduced in a phased manner from 20.25 per cent currently to 20 per cent by December 2017 and to 19.5 per cent by March 2018.

Rationale: Despite acknowledging weaker growth, the RBI stayed put due to a 2 percentage point (pp) rise in inflation since August’s policy meeting, heightened financial market volatility due to global developments (Fed balance sheet unwinding and a risk of policy normalisation by the ECB), higher oil prices and potential inflationary pressures from fiscal slippage.

Economic outlook: The RBI projects inflation (including the central house rent allowance) to rise from current levels to 4.2-4.6 per cent in H2 FY18 (year-ending March 2018), which is marginally higher than the projection made at the August policy meeting (of ~4.5 per cent by Q1 2018). However, it lowered its FY18 (year ending March 2018) GVA growth projection to 6.7 per cent y-o-y from 7.3 per cent with balanced risks (also from August).

Forward guidance: The RBI acknowledged the possibility of slowing growth (widening output gap) but nevertheless maintained its neutral policy stance, stating that it “requires more data to better ascertain the transient versus sustained headwinds in the recent growth prints”.

Nomura’s view: The RBI’s decision to maintain the status quo is indicative of its inclination to look through the near-term outlook, which is clouded by transitory factors and concerns over higher core inflation. Overall, the policy appears neutral. In our view, growth has bottomed out and we expect a recovery, led by ongoing progress following remonetisation, restocking efforts following the implementation of the GST and the lagged effects of lower lending rates. We also expect inflation to rise above 4 per cent in coming quarters, as we expect the output gap to gradually narrow, as well as on statistical and transitory factors such as the house rent allowance increases and the lagged pass-through from the GST tax changes. We also see a higher probability that the central government will miss its budgeted fiscal deficit target of 3.2 per cent of GDP in FY18 by 0.3pp. Against this backdrop, we expect the RBI to leave policy rates unchanged in our base case. Weaker-than-expected growth, an undershooting of the 4 per cent inflation target and the government sticking to its budgeted fiscal consolidation target could open up room for more accommodation, in our view.

(with Neha Saraf)
(The writers are research analysts at Nomura)