RBI likely to maintain status quo and focus on liquidity in upcoming Dec 5 meet

Although there is unanimity with respect to the policy rate expectation, opinions remain divided on how the RBI will address liquidity issues.

Dec 04, 2018 10:12 IST India Infoline News Service

In the fifth bi-monthly meeting, the monetary policy committee (MPC) is likely to maintain status quo given that retail inflation has fallen to a 13-month low in October 2018 and remains below the targeted inflation rate, i.e. 4%, for the third consecutive month.
CPI Inflation (yoy)
Source: tradingeconomics.com, MOSPI

Retail inflation eased to 3.31% yoy in October 2018 vs. 3.7% in September 2018, below the medium-term inflation target of 4% for the third straight month. Further, inflation is expected to be below 3% for November as per consensus estimates.
The RBI in its MPC meet in October mentioned that it was predominantly focused on inflation targeting; hence, the market expects the next rate hike only in 2019-20.
It should be noted, however, that in the last meet, the RBI changed its stance to “calibrated tightening,” signaling that there may be scope for a rate hike, but no scope for a cut. Thus, the Repo rate and Reverse Repo Rate are likely to be steady at 6.50% and 6.25%, respectively.
Besides, a lower-than-expected GDP growth rate of 7.1% in the second quarter (July–September 2018) despite a favorable base last quarter also supports the case for holding the policy rate steady.
GDP qoq growth (%)
Source: tradingeconomics.com, MOSPI
In the August meeting, the RBI had raised the Repo rate and Reverse Repo Rate by 25bps to 6.50% and 6.25% respectively, fearing rising inflation. However, it had maintained a “Neutral” stance.
Crude oil prices correcting to below $60 levels after hovering around $86/barrel in early October reduces inflation risk to a considerable extent. The rupee has also stabilized to Rs70/$ levels from lows of ~74/$ in October.

Source: tradingeconomics.com

How the RBI will deal with the liquidity situation will also be keenly watched. The RBI has, so far, infused liquidity of Rs1.36 lakh cr through open market operations (purchasing government bonds). Apart from this, the RBI is likely to infuse additional Rs40,000cr in December 2018 to cope with the liquidity crisis. Despite these initiatives, the system liquidity deficit continues to remain ~Rs1 lakh cr.
Thus, although there is unanimity with respect to the policy rate expectation, opinions remain divided on the liquidity issue.
With the government likely to slash spending in the run up to elections to meet its fiscal deficit target, some expect the RBI to either trim the cash reserve ratio or relax the statutory liquidity ratio (SLR) to ease the liquidity situation.
Currently, fiscal slippages, the liquidity situation, and volatile global financial markets remain key factors/risks on RBI’s radar.

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