As was widely expected, the Monetary Policy Committee of the Reserve Bank of India (RBI) kept its policy rates on hold on Thursday, but projected a fairly dovish outlook on inflation and growth — something that sharply contrasts with the hawkish tone till about February when the last policy review was undertaken. Complementing the softer inflation outlook was the cheerful expectation on growth — gross domestic product is expected to grow at 7.4 per cent in 2018-19 because of “several factors that are expected to accelerate the pace of activity”. Both the macroeconomic variables present a perfect picture for the government, which is starting an election year.
This positive sentiment had a rub-off effect on bond yields, which fell sharply. The 10-year government bond yield fell from 7.28 per cent just before the policy announcement to 7.16 per cent. Bond yields, which had run up from 6.5 per cent in August to 7.7 per cent in March, have been going down after the government announced a lower-than-expected borrowing requirement in the first half of 2018-19, including shorter tenure bonds. The RBI’s decision on Monday to allow banks to spread over four quarters their mark-to-market losses incurred due to the adverse yield movement in the December and March quarters, further exerted downward pressure on yields. Banking stocks gained as well, and for good reason — in its monetary policy statement, the RBI decided to defer the adoption of the Indian Accounting Standards (Ind AS), which were expected to make provisioning for bad loans more stringent. The RBI pointed out that the legislative amendments required were still under the government’s consideration and many banks were perhaps not yet fully prepared for the transition.
Amid the overall cheer, however, there is some room for caution over the RBI’s inflation outlook. The downward revision of expected inflation in the second half of 2018-19 is easy to understand – after all, food inflation, especially that of vegetables, has come down by 120 basis points since the monetary policy committee met last. There are reasons to believe that this trend will sustain for some time. But the 4.4 per cent retail inflation forecast for the second half of the year could well run into trouble for a variety of reasons. For one, even now, core inflation continues to remain elevated. As far as food inflation is concerned, it should be borne in mind that the government has given strong indications that it is likely to use minimum support prices to boost agricultural incomes. Doing so will have a direct impact on food inflation. There are already existing worries about fiscal slippage, both at the Centre and in states, as the country gets into election mode later this year. These, together with domestic variables, volatility in crude oil prices and a global demand disruption due to possible trade wars have the potential of upsetting the central bank’s calculations. The RBI is obviously aware of this, which is evident from Governor Urjit Patel’s media statement that there are several uncertainties around the baseline inflation path. That is why the central bank has kept its stance neutral and rate unchanged.