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Too early for a rate hike, RBI; a hawkish tone should be enough

By Siddhartha Sanyal

The Reserve Bank of Indias (RBI) monetary policy decision in June is a close call. Higher oil prices, a wider current account deficit, and a weaker rupee have led to an increase in Indias perceived risks of late and likely will prompt the monetary policy committee (MPC) to turn materially more hawkish.

However, Indias growth-inflation dynamics does not warrant an immediate rate hike, in my view. CPI inflation, despite some upside pressures of late, is poised to average sub-5 per cent during 2018-19 and stay well within the MPCs target range. Growth is improving, but is still in the early stages of recovery and far from triggering any overheating concerns. On balance, it would make sense for the MPC to adopt a hawkish tone, but to stay on hold in June.

There had been considerable discussions of late on rising core inflation. CPI inflation excluding food, tobacco, and energy – the so-called core CPI – inched up in recent months to reach 5.8 per cent in April, rising about 80basis points (bps) since January 2018. However, a large chunk of the same was triggered by a sharp rise in prices of the energy component under the transport segment of the so-called core CPI basket (petrol and diesel for vehicles, and lubricants and other fuels) and the continued rise in housing inflation reflecting higher house rent allowances (a statistical factor).

Excluding these components (i.e. core CPI ex-housing and transport fuel), the contribution from other core components has risen only modestly in recent months. Thus, core inflationary pressures are largely housing- and energy-centric and not broad based.

Risk perception around the Indian economy escalated relatively quickly since the last MPC meeting. For instance, the MPC maintained a largely balanced to dovish tone as late as in April (though the minutes of the same meeting published in late-April were surprisingly hawkish!).

The most important factor influencing an escalation in risk perception during this period had been oil prices, which went higher by about $10 a barrel since early-April. While the rise in oil prices since April had been sharp, Brent futures continue to suggest a gradual softening in prices in the coming months.

Given that the pressure on oil prices emanated only weeks back and a number of forecasts suggest softening in prices in the coming months, there is merit, in my view, in the MPCs not been in a rush in June to hike the repo rate.

If oil prices indeed start turning lower, perceived risks around a number of variables (e.g., inflation expectations, CA deficit, INR) could dissipate materially and rapidly. With a likely materially softer set of inflation prints towards the end of 2018, a hike in June would appear misplaced at that juncture.

On the other hand, a wait for another eight weeks would offer greater clarity on trends of a number of key factors such as oil, monsoon, and the near term peak of the CPI trajectory. If risk perception refuses to fade by then, the MPC might have a stronger case to act.

However, at the current uncertain times, pragmatism might be proven a better choice over prompt action.

(Siddhartha Sanyal is Chief India Economist, Barclays. Views are his own)

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