The fact that the MPC has swiftly responded to the upside pressures on inflation should address fears that the committee structure was making decision making sluggish and the questions about the RBI’s independence. This we believe is a healthy development.
The MPC unanimously decided to hike the policy rate by 25 bps today. The hike was in response to various upside risks (oil and core) that have unfolded since the last monetary policy meeting. As per the policy statement, while the MPC took into account the recent increase in oil prices and persistent core inflation (excluding food, fuel and HRA), two important drivers (of inflation) were left out – the expected hike in Minimum support prices and the impact of the recent rupee depreciation (which could have an inflationary impact across the board for imported items). Just to recall, as per the April monetary policy report, the RBI had assumed USD/INR level of 65.04.
The MPC also revised up its inflation estimate for FY19 from 4.65% to 4.85% (H1: 4.8% to 4.9%, H2: 4.7%), however, we believe there could be further upside to these numbers. Taking into account the rise in oil prices, marginal depreciation in the rupee, and the expected increase in MSP for the upcoming Kharif season, we expect CPI inflation to average at around 5.1% in FY19.
Despite hiking, the monetary policy stance was left unchanged as “neutral”. The MPC justified this by saying that they would be data dependent, keeping the window open for a prolonged hold going ahead. However, given the rising inflationary pressures and the possibility of an overshoot above the RBI’s projected path for inflation, we believe this is just the beginning of a rate hike cycle. There could be further monetary policy action warranted with at least one more 25 bps rate hike before the end of the year.
Liquidity: Some of the pressures of a rate hike (today) are likely to get offset by enhanced use of SLR to meet LCR requirements. The RBI permitted banks to use government securities held by them upto 2% of their NDTL within the mandatory SLR requirement for their LCR requirements in addition to the current existing assets. Hence the total carve-out from SLR available to banks would be 13% of their NDTL.
FX and Bonds: Today’s rate hike was largely priced in by the markets. However, there could still be some more upside to bond yields, on expectations that inflation could continue to surprise on the upside. Consequently, we also expect marginal appreciation in the rupee to come back. Although gains in the rupee could be limited ahead of the Fed policy meet (12-13 June) and rising geopolitical tensions in the euro zone (which could trigger a risk off scenario against emerging markets in general). We expect bond yields to climb up to 8.2% by the end of the fiscal and the rupee to depreciate by 3% in FY19 (One-month range: 67-67.5 against the dollar by June-end).
*Mr. Abheek Barua, Chief Economist, HDFC Bank. Mr. Barua tweets at @AbheekHDFCBank.
