MONETARY POLICY

REVIEW
RBI TURNS MORE DOVISH, BUT KEEPS KEY RATES ON HOLD
2 Monetary Policy Review

JUNE 2016

The Reserve Bank of India or RBI kept key rates on hold while turning more dovish.
The inflation forecast for the first-half of the fiscal year was lowered to 2.0%-3.5%
from 4.5% earlier, while the forecast for the second-half was cut to 3.5%-4.5% from
5.0% earlier. In our view, Consumer Price Index or CPI inflation is likely to be well
within the RBI's revised target for 1HFY18,while it may overshoot the central bank’s
target in the second-half and average about 4.9% (excluding the house rent
allowance or HRA component recommended by the Seventh Central Pay
Commission), and about 5.7% including the HRA component.

However, the next two inflation readings before the August 2017 policy meeting are
likely to be well under 3%. The chance of a rate cut at the August meeting has now
increased, particularly if the RBI bases its decision on the inflation readings of the
preceding two months. There was one dissenting vote at the latest meeting, but
taking a decision at the August 2017 meeting is likely to be even tougher.
Nevertheless if the RBI chooses to cut key rates in August 2017, it will not been very
long before the RBI will have to increase rates, as we continue to expect a rate hike
in early 2018 as inflation picks up.

The rate hikes, after a cut, may need to be more aggressive than otherwise
warranted. Should the RBI pause in August 2017, and see through the soft patch of
inflation, the rate hikes could be pushed back even if inflation witnesses an uptick
in the second-half of the year. The Statutory Liquidity Ratio or SLR was cut by
50bps to 20% to allow banks the room to meet their Liquidity Coverage Ratio or LCR
requirement under BaseI III regulations.

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