Uncertain Inflation Outlook Prompts MPC To Pause
With the disinflation in food prices posing a stark contrast to the elevated core CPI inflation, the Monetary Policy Committee (MPC) left the repo rate unchanged at 6.5% and retained the monetary policy stance at calibrated tightening in the December 2018 policy review, in line with our expectations.
Nevertheless, the decline in the headline CPI inflation to 3.3% in October 2018, prompted the MPC to sharply revise its inflation forecasts downwards. The CPI inflation has now been projected at 2.7-3.2% in H2 FY2019 and 3.8-4.2% in H1 FY2020, with risks tilted to the upside.
The Committee highlighted the uncertainty related to various inflation risks such as prices of food and fuels. In our view, the delayed rabi sowing and the potential impact of revised minimum support prices for various crops on market prices, suggest that the disinflation in food prices may not sustain. While geopolitical developments and supply-demand balances would continue to affect crude oil prices and the outlook for the currency, we do not expect in a sharp rebound in crude oil prices or a re-testing of the all-time low by the INR in the near term.
The MPC also emphasised the potential impact of volatile global financial markets and domestic fiscal slippages on the inflation outlook.
The Committee retained its growth forecast for FY2019 at 7.4%, and placed the same for H1 FY2020 at 7.5% with risks tilted to the downside. With capacity utilisation improving to a seasonally adjusted 76.4% in Q2 FY2019, the Committee highlighted that the output gap remains virtually closed. Moreover, it expects the reversal in crude oil prices to improve corporate earnings and the purchasing power of households. Nevertheless, lagging rabi sowing and the impact of trade tensions on exports were flagged as risks.
To align it with the liquidity coverage ratio, the Statutory Liquidity Ratio (SLR) is proposed to be cut by 25 bps in each quarter starting Q4 FY2019 for six consecutive quarters. This is expected to be relatively more positive for private sector banks, as their SLR holdings are closer to regulatory requirements, than for public sector banks. Despite the already high credit - deposit ratio, the proposed SLR cut would enhance the ability of private sector banks to deploy their deposits in higher yielding loan assets. On the other hand, public sector banks would need to improve their capital position to benefit from the lower SLR requirements.
While the vote on maintaining the repo rate unchanged was unanimous, there was one dissent in favour of changing the stance back to neutral. At present, there appears to be a significant likelihood of a change in the monetary policy stance to neutral from calibrated tightening in the February 2019 policy review, in ICRA’s view.
