India Economics:Minutes of the MPC –Concerned about upside risks to inflation

Minutes of Feb MPC meeting released: The RBI released today the minutesof the MPC meeting held on February 6-7, 2018. Recall, the RBI had held keyrates unchanged with a vote of 5-1, with MPC member Dr. Patra dissentingfor a 25bp rate hike. In our view, the MPC minutes came across as slightlymore hawkish (at the margin) compared to the overall tone of themonetary policy statement of 7th Feb.

Upside risks to inflation remain a concern: The MPC minuteshighlighted that all members remain concerned regarding upside risks toinflation, especially as various measures of inflation seem to beconverging above the 5% mark. The risks to inflation as per the MPCmembers stem from (1) fiscal slippage in the current year and the delayin achieving the fiscal consolidation roadmap, (2) inflationary impactfrom government’s policy to fix minimum support prices at 1.5x cost, (3)custom duty hikes announced in the budget, (4) turn in globalcommodity prices (though members also highlighted the possibility of oilprices to correct as supply-side response evolves) and (5) uncertaintyfrom monetary policy normalization in developed economies. On thedownside, the likely supply-side response and impact on oil prices,overcapacity in the system and government’s food management policywere alluded to.

Getting more confident about rebound in growth: The members notedthat incoming growth data is pointing towards strengthening growthmomentum. Members seemed more confident about the recovery ingrowth and it not being just a base effect related increase in growth.

What made the majority of the members vote for a pause despitehighlighting upside risks to inflation? The nascent growth recovery,which needs some support, has been cited as the key reason that madethe majority of the MPC members vote for a pause.

Our view – Extended pause, MPC to remain vigilant: We expect RBI tokeep policy rates on pause in 2018 as we expect inflation to moderatetowards 4% in 2HFY19 (from 5.3% in 1HFY19e). While inflation will remain onan upward trajectory in 1H18, growth recovery still remains nascent in ourview, keeping the balance in favour of a pause. While we do not expect a ratehike in 2018, we highlight the risk that a rate hike could be brought forward to2H 2018 driven primarily by inflation coming in higher than RBI’s expectationfor 2HFY19 (due to hardening of oil price/ significant pass through from MSPprice hikes / poor monsoon) and or better-than-expected growth conditions.

Global factors such as the pace of policy normalisation by the US Fed andassociated impact on external stability could also force rate action by the RBI.

Indeed as highlighted by MPC member Dr. Acharya in the minutes, “The nextfew months of inflation and growth data will be key to determining theevolution of policy rates. If growth remains robust and inflation prints continueto project headline inflation a year ahead well above the target, then a changein stance from "neutral" to "withdrawal of accommodation" might have to beconsidered.”