Today’s monetary policy announcement was significant for three reasons. Not only it was the first policy review of this year, it was also the first one with the new RBI governor at the helm. And it followed the interim budget announced earlier this month.
With headline inflation remaining well below RBI’s medium-term target of 4%, on account of significant undershooting in food inflation, and the benign outlook in the near term, we believe the softening of stance is in the right direction.
That said, there seemed to have been opposing views on domestic growth conditions. Opening up of the output gap, i.e., actual growth falling below the potential (in last two policy meets, this gap was almost closed) and improvement in capacity utilisation at the same time appears to be somewhat at odds. RBI also continued to maintain its earlier growth forecast of 7.4% for fiscal 2020.
Some risks to inflation can emerge from consumption focused expansionary fiscal policy, sticky core inflation, and normalisation of food inflation (currently negative) which could gain speed if monsoons are sub-normal. Moderate upturn in global food prices and efforts to raise farm incomes can put upward pressure on inflation. The MPC itself suggested that several proposals in the interim budget are likely to boost aggregate demand by raising disposable incomes, which can push core inflation up further. RBI’s inflation assessment does not see these risks as material as it forecasts CPI inflation at 3.8-4.2% for the first half of fiscal 2020 and 3.9% in the third quarter.
Given that the risks to both inflation and growth are evenly distributed, future decision on policy rates would be data driven. CRISIL forecasts CPI inflation at 3.7% in fiscal 2019 and 4.5% in fiscal 2020.