Status quo likely in RBI policy, but outlook matters more than the action

In the February monetary policy review, the RBI rightly batted for growth and refused to be an inflation hawk. If the events of the past two months are any indicator, it made the right call.

In the first MPC (monetary policy committee) meeting of the new fiscal, we expect this trend to continue. Inflation appears to be under control, but growth remains an issue, more so in the light of the latest problems in the Indian banking system.

RBI’s outlook on growth, on banking sector regulations, and on medium term inflation will be keenly watched though the consensus view on the street is that benchmark rates will be unchanged.

The yield on the 10-year government bond has cooled off since the last policy review, thanks to the lower borrowing target (47.6% of the gross borrowing target) in the first half of FY19.

The trajectory of retail inflation also provides comfort, riding on softer food inflation.

There is hope of a normal monsoon as the Indian Meteorological Department, has ruled out the possibility of El Nino, at least till August 2018. We expect the base effect to support the benign inflation trend in the second half of the year.

While prices have been in the comfort zone, so has been the disaggregate growth number like the Index of industrial production (IIP). IIP has shown growth recovery since November 2017, led by manufacturing although the low base of demonetisation partially explains the same. Since GST disruption also marred growth last year, a part of this base effect benefit will be visible in the coming months as well.

What are the clouds to watch out for?

Even as the sky appears clear for now, there are dark clouds looming on the horiozon.

Post the February policy, the largest scam in Indian banking history surfaced. Incidentally, on 12th of February 2018, RBI had released a circular that abolished all erstwhile categorization of standard stressed assets – SDR, S4A, CDR restructuring, and flexible restructuring under 5:25 scheme by banks leaving IBC  (insolvency bankruptcy court) as the only resolution mechanism. This circular coupled with the higher level of scrutiny on the books post the banking fraud (and several being reported now) will keep non-performing assets and provision level elevated for banks in the coming fiscal as well.

While banks have been given temporary relief by being allowed to stagger their bond portfolio losses (due to rise in G Sec yields) over four quarters, the above mentioned developments will surely push the capex cycle further as most banks in the system choose to play safe for a while. RBI’s take on this subject (as the regulator of the sector) will be of interest to the market.

Thus while credit growth has recovered to double digits(thanks partly to the demonetisation base), sustainability remains a question.

Fiscal slippage – a genuine risk?

Despite the temporary comfort on crude price, RBI would be mindful of the risk emanating from uneven distribution of monsoon, inflation stoking freebies in an election year, and the decision on minimum support price at 1.5x of the cost (as and when implemented).

On the fiscal front, the targeted 3.3 percent fiscal deficit to GDP ratio for FY19 prima facie looks credible. But there are challenges. GST collection has been stagnating and all eyes are now on implementation of E-way bills to lift the same. The disinvestment target too looks tall (Rs 80,000 crore) given the subdued mood in the stock market and the value that the Air India stake sale will fetch. Finally, the budget will have to find money for allocation to the Universal Health Insurance Scheme, should it get implemented in the election year.

Protectionism – India cannot remain unscathed

On the global front, while some industrial commodities have cooled a tad post the trade barriers erected by US President, crude continues to stay firm, much to our discomfort.

Rising protectionism itself can hurt global growth, which in turn could impact our exports and currency. These are emerging concerns that RBI got to be mindful of.

While domestic liquidity is almost in a neutral zone and hence wouldn’t grab much of attention and FII flows have been supportive despite volatile stock markets, there are too many imponderables.

Thus, while RBI is likely to deliver a status quo on rates on expected lines, in view of the myriad local and global uncertainties, the outlook assumes far more importance than the action.