RBI's inflation, GDP projections put economy in 'golden spot'

The Reserve Bank of India's (RBI) projections of a softer consumer price index (CPI) inflation and maintenance of the earlier GDP growth rate in the fifth monetary policy review announced on Monday have put the economy in a "golden spot".

The central bank has forecast retail inflation to ease further to 2.7-3.2% in the second half of the current fiscal and maintained the GDP growth rate for FY19 at 7.4%.

D K Srivastava, chief policy advisor, EY India, told DNA Money the apex bank's outlook on these two parameters puts the economy in "a kind of golden spot".

"(RBI's) stance is still maintained at calibrated tightening. Overall RBI sees growth as well as inflation in a robust regime, with a growth rate of about 7.4% and inflation below 4%, which is a kind of golden spot for economy in terms of macro parameters," said the EY economist.

In its last policy review, the central bank had predicted CPI inflation to be at 4% in the second quarter, 3.9-4.5% in the second half of the current quarter and 4.8% in the first quarter of the next fiscal; with an upside risk. Excluding the home rent allowance (HRA) impact, RBI had pegged inflation at 3.7% in the second quarter, 3.8-4.5% in H2 and 4.8% in Q1 of FY20.

However, the actual inflation numbers have surprised everyone with Q2 headline inflation coming at 3.9% and the October inflation "turned out to be unexpected low" at 3.3%.

"Retail inflation, measured by y-o-y (year-on-year) change in CPI, declined from 3.7% in September to 3.3% in October. A large fall in food prices pushed food group into deflation and more than offset the increase in inflation in items excluding food and fuel," stated the RBI note.

With these developments and assuming a normal monsoon in 2019, the central bank has revised its inflation projection downward at 2.7-3.2% in H2 of the current fiscal and 3.8-4.2% in H1 of 2019-20; "with risks tilted to the upside."

"Although recent food inflation prints have surprised on the downside and prices of petroleum products have softened considerably, it is important to monitor their evolution closely and allow heightened short-term uncertainties to be resolved by incoming data," said the resolution statement of the RBI.

Governor Urjit Patel said a few more data points would be needed to confirm the "durability of the declining inflation".

"We need a few more data points to ascertain the durability of the declining inflation that has taken place in a very short period of time. Especially with respect to oil, the implied volatility is now actually higher than October, although the price has come down. So, with incoming data, our projection will change and we will take a call, as and when required," he told reporters after announcing the monetary policy.

Viral Acharya, deputy governor of RBI, said the 12-month inflation projection was still higher than the central bank's medium-term target of 4%.

"The volatility of data makes the decision somewhat difficult, but I would like to stress two things. One, we have to look at inflation staying at our target rate in medium-term horizon. In some sense at Q2 of 2019-20, the number is 4.2%, which is basically implying that as of now we are slightly above the target at a 12-month horizon. What has happened is that the two surprises in food and oil, in a very short period of time, have brought the projections down quite significantly. Nevertheless, medium-term target actually remains above the headline target," he said.

Abhimanyu Sofat, head of research, IIFL Securities, said RBI should have been less "hawkish" on a milder inflation outlook given by it.

"The reduction in inflation forecast to 2.7-3.2% from 3.9-4.5% should have ideally lead to a lesser hawkish monetary policy. As the shift in policy stance was done in the last meeting it was difficult for RBI to reverse the same. If one sees continued benign data on inflation front, then one can hope for increased liquidity from RBI going forward to support credit growth," he said in statement issued by IIFL Securities.

Buoyed by accelerated investment activity, slide in crude prices, increased capacity utilisation and other positive economic indicators, the central bank held to its previous GDP growth forecast of 7.4% for this fiscal and 7.5% for the first half of next fiscal; with a downside risk.

"Turning to growth projections, although Q2 growth (7.1%) was lower than that projected in the October policy, GDP growth in H1 has been broadly along the line in the April policy when for the year as a whole GDP growth was projected at 7.4%. Going forward, lower rabi sowing may adversely affect agriculture and hence rural demand. Financial market volatility, slowing global demand and rising trade tensions pose negative risk to exports," said the resolution statement of the central bank.

According to Srivastava, downside risks, if at all, will be played out by external factors. "I think most of the uncertainty comes from external factors. Since in the second quarter the contribution of exports, net of imports, was negative to growth. The main risk is whether or not global tariff and trade climate would improve. And if so, that would probably eliminate the risk," he said.