Improved growth outlook but rising inflationary risk
The monetary policy statement summarizes a scenario of nascent turnaround of growth along with higher inflation risk. However, the RBI appears less confident about the cyclical improvement as its sees GVA growth moderating in the H2FY19 to 7.1-7.2% after improving to 7.3-7.4% in H1FY19 from an annual growth of 6.6% in FY18, which is a downward revision from 6.7% as per RBI’s earlier projection. Inflation is also expected to harden to 5.1-5.6% in H1 before moderating to 4.5-4.6% in H2. However, the guidance is towards higher inflationary risk and balanced growth risk at the terminal point.
We believe that RBI’s overall assessment is little more hawkish than the series of hawkish undertone it has articulated in the recent earlier statements. This element of hawkishness is guided by the assessment of the recently announced Union Budget, which is expected to add to the inflation momentum and leading indicators suggesting impetus to core inflation from rising input costs.
Our assessment and outlook: RBI to hike rates by 25bps in next policy
The tone of the monetary policy increasingly sounding hawkish is evolving in line with our long held view. The latest statement possibly is a prelude to a tightening move even as RBI maintains its current neutral stance. We believe, the conviction towards this shift will fortify once the inflation ranges in between 5.5-6.0% in H1FY19. With improving growth dynamics and inflation, credit growth will likely head higher in FY19 to 14-15% from our current projection of 12-13% in FY18. This is likely to lead to further tightening in liquidity conditions. Tightening liquidity conditions, fiscal slippage (relatively higher reliance on borrowing), potential INR depreciation and hardening of global yields are expected to push up Gsec yields further to levels above 8% for 10 year maturity. Also, the underlying risk of rupee depreciation, which again has been highlighted in the RBI policy, is in line with our assessment observing the rising risks of twin deficits.