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RBI raises rates, more to follow

RBI raised policy rate by 25bps with a 6-0 vote while maintaining a neutral policy stance. The recent upturn in the economy (GDP growth at 7.7%) along with sharp jump in CPI inflation excluding food and fuel to 5.9% seems to have weighed in favour of a rate hike. While CPI inflation is likely to moderate from an average of 4.8% in Q1FY19, we believe average inflation is likely to remain above 4% over the medium-term because of which RBI is likely to raise rates by another 25bps in CY18.

H2 inflation forecast revised upwards: Given the sharp increase in international oil prices and build-up in CPI inflation excluding food and fuel to 5.9% in Apr’18, RBI raised its H2 inflation forecast to 4.7% from 4.4% earlier. Hence, CPI inflation is likely to average 4.8% in FY19 (our forecast: 4.4%). More importantly, CPI inflation is likely to remain above 4% even in FY20 as food inflation is likely to move higher in-line with government policies of ensuring higher farm incomes.

Key Highlights

  • RBI raises policy rate by 25bps, policy stance remains neutral
  • Inflation projection for H2FY19 revised upward to 4.7% from 4.4%
  • GDP forecast retained at 7.4% for FY19

Growth trajectory is steady: RBI maintained its growth forecast at 7.4% in FY19 on the back of buoyant consumer demand and pick-up in investment activity. Exports are also likely to improve as global demand is steady. While higher oil prices will impact disposable incomes, a normal monsoon along with improvement in credit off-take will ensure that growth trajectory remains steady. MPC members also believe that output gap has almost closed.

RBI to raise rates by another 25bps: With inflation likely to remain above RBI’s medium-term target of 4%, our estimate is 4.4% for FY19, we believe RBI is likely to raise policy rates by another 25bps in the current financial year. Given that next few inflation prints are likely to be elevated, there is a high probability that RBI raises rates either in August or October. While inflation is likely to moderate from Q1FY19, there are significant upside risks to this trajectory. First, food prices may rise faster than our estimates if MSPs are greater than anticipated. In addition, if oil prices move higher than inflation estimates have to be revised upwards. Last but not the least, if FPI outflows continue at same pace as last two months, then RBI may be under pressure to raise rates to ensure stable currency.

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