WWRR Vol.2.015

India Economics | 28 th November 2018
RESERVE BANK OF INDIA WATCH
On hold for now, but tightening cycle not over yet
The recent drop in headline inflation, coupled with
the sharp fall in global oil prices, should be enough
to ensure that the RBI keeps policy rates on hold at
the conclusion of its meeting on Wednesday 5 th
December. However, with core inflation still
elevated and the MPC placing significant emphasis
on ensuring that it doesn’t fall behind the curve and
compromise its credibility, we think the tightening
cycle still has a little bit further to run.
Latest data gives RBI some breathing space
The MPC unexpectedly kept its repo rate and reverse
repo rates on hold at 6.50% and 6.25% respectively
at its October meeting, having hiked both rates by a
cumulative 50bp at the two previous meetings. The
committee did change its official policy stance to
“calibrated tightening” in October, but we don’t
think this signals any inevitability about the outcome
of its upcoming meeting. The mantra from Governor
Urjit Patel continues to be that the future path of
monetary policy is highly data dependent.
On balance, the recent data have provided the RBI
with a bit more breathing space. There have been
signs of a slowdown in some of the latest activity data
including vehicle sales, tourism arrivals and
industrial production. (See Chart 1.) We think that
GDP will also have slowed a touch in Q3 (the data
are due to be released this Friday).
Chart 1: Industrial Production
10 % y/y
% y/y, 3ma
8
6
4
2
10
8
6
4
2
projections. The latest data show that CPI inflation
eased to 3.3% y/y in October, from 3.7% y/y in
September. The recent plunge in oil prices provides
more space. We estimate that every sustained $10pb
fall in the price of oil knocks about 0.1%-pt off the
headline rate of inflation. The recent drop in global
prices was in line with the long-standing forecasts of
our Commodities team, and therefore doesn’t
change our expectations for inflation in India. But it
should lead to headline inflation being 0.2-0.3%
points lower than it would otherwise have been.
The other factor that may tip the balance in towards
a hold is the recent calm in financial markets. For
example, the rupee has strengthened by nearly 3.5%
against the US dollar since hitting a record low in late
October. (See Chart 2.) The MPC therefore has less
reason to be concerned that keeping rates on hold
might antagonise markets than would have been the
case a few weeks ago.
76
74
72
70
68
66
64
62
Chart 2: Rupee vs US$
Rupee weaker
vs. US$
60
Jan-17 May-17 Sep-17 Jan-18 May-18 Sep-18
Source: Bloomberg
In all, we think the repo and reverse repo rates will
be kept unchanged next week. This forecast is shared
by the consensus. At the time of writing, 13 out of 16
analysts on the Bloomberg poll expect no change.
76
74
72
70
68
66
64
62
60
0
-2
2014 2015 2016 2017 2018
Sources: CEIC, Capital Economics
In addition, headline consumer price inflation has
dropped below the RBI’s 4.0% target in recent
months, undershooting the central bank’s
0
-2
Tightening cycle still has a little further to run
However, we don’t think that a second hold in a row
means that the tightening cycle has ended. While
economic growth has probably passed its peak, the
big picture is that the economy is still performing
well and we expect this to continue for a while
longer. (For more see our India Economic Outlook,
Shilan Shah, Senior India Economist, +65 6595 1511, shilan.shah@capitaleconomics.com