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RBI MPC meeting - Would status quo prevail?

After the relatively bland budget, all eyes are now on the next major event, RBI's monetary policy meeting. In today's post, we discuss the macro-economic environment in which the MPC makes the decision, the expectation the market seems to have around the decision, and potential implications if those expectations aren't met.

The background:

7.35% inflation and Operation Twist have been the two major monetary policy moving events since the MPC's last meeting in which, contrary to most economist expectations the committee had decided to hold rates. We had covered both of these events in quite a lot of details in our earlier posts, which you could read through the links above.

Operation Twist was the RBI's way of ensuring better rate transmission which goes to show the central bank's displeasure at the current extent of transmission in the system. The 7.35% inflation was significantly above the RBI's state band of 2%-6% and spooked quite a few people as well, although the drivers of that were expected to vegetable price-driven inflation, expected to come down in subsequent months, the RBI might want to see a few months of stability before gaining confidence that the number is under control. We enter this policy meeting in the backdrop of these factors with a sharp 135bps drop in 2019.

Market Expectations:

The market, for the most part, is expecting the RBI to keep rates unchanged driven primarily by the above two factors. While the declining growth rates, languishing at close to 5% now are a matter of concern, the consensus seems to be that the RBI is looking to ensure better transmission of the cuts it has already brought in, before coming up with new ones. The inflation numbers give it a good reason to defer a rate cut, atleast until the next meeting where there will be greater clarity in whether the number has been stabilizing as expected.

On the RBI's stance which currently stands at accommodative, all but one believe it to be maintained. The only potential reason for a switch to neutral in the current environment would be in reaction to the inflation spike, with the assumption that the central bank becomes exceedingly cautious on the back of the event, which, when you scratch a little bit deeper into the number seems highly unlikely. A move to neutral with have a sharp negative impact on the markets given the extremely limited fiscal space the government has shown to revive growth.

Surprise surprise?

Given the rate assumptions the market is going in with, any rate cute will be a strong positive and should help continue the market rally. The only potential rationale for a cut now would be desperation to revive growth on the central bank's side, given the severe lack of bandwidth shown by the central government. The event, however, seems extremely unlikely given the current inflation environment and the RBI's steady focus on it.

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