India: RBI holds rates; to keep a close eye on inflation risks

  • RBI kept rates unchanged in today’s meeting (as per expectations)
  • Given focus on term repo, the overnight repo limit has been reduced to 0.25% of NDTL while term repo limit hiked to 0.75%
  • Our inflation projections on assumption of a normal monsoon signal an extended pause on rates. However, the RBI would remain cautious of possible re-emergence of food price pressures and stickiness in core inflation

In the April policy meeting, the RBI kept rates unchanged as per expectations.Meanwhile, the limit for overnight LAF has been reduced to 0.25% of NDTL from 0.5% while that for 7 and 14-day term repo has been raised to 0.75%.


RBI to continue to follow glide path on CPI to take policy decisions

The RBI has reiterated that if CPI inflation continues to remain in line with the intended glide path (to bring down CPI to 8% an
d 6% by January-2015 and 2016 respectively), the RBI does not anticipate further tightening in the near term.


Upside risks to inflation remain

The RBI highlighted possible upside risks to inflation emanating from a less than normal monsoon (amid El Nino fears), uncertainty over minimum support prices and fiscal policy adopted by the new Government. Moreover, the RBI has emphasized that it would look through the impact of transient
effects (including base effects) on he adline inflation, while taking policy decisions.

Growth projected to recover though downside risks remain
Real GDP is projected to improve to 5-6% in FY2015 from a little below 5% in FY2014. Meanwhile lead indicators point to continued sluggishness.


FII investments in T-bills curbed
The RBI clarified that the reliance on short-term flows for financing of current account should be reduced. Hence, the FII investments have henceforth been permitted only in dated securities of residual maturity of 1-year and above and existing investment in T-bills will be allowed to taper on maturity/sale.

The measure is likely to result in FII outflows (~USD 5 bn) from the T-bill segment in the coming months. This is likely to result in an upward pressure on the shorter end of the curve, given that outstanding FII investment in T-bills is INR 346 bn and the budgeted borrowing in T-bills has been raised to INR 336 bn in the current fiscal versus INR 227 bn in FY2014. Meanwhile,
impact on Rupee is likely to be capped on account of a sharp improvement in current account deficit.

RBI to remain in a wait and watch mode
The clear policy communication suggests that decisions would be based on the glide path of CPI inflation. Hence, the RBI would cautiously track the impact of various factors posing upside
risks to inflation. In particular, the Central Bank would watch for the trend in core CPI inflation that has remained sticky over the last few months.

On the assumption of a normal monsoon, we expect average CPI inflation levels to trend lower in FY2015 and remain
within the 8% target till January-2015. While the projections
signal extended pause, we believe that policy decisions will be data dependent with the RBI remaining cautious on possible
re-emergence of food price pressures and stickiness in core inflation.