Schroders: Indian central bank holds its ground as growth slows

In a briefing after the decision announcement, central bank governor Urjit Patel expressed concern about the loss of economic momentum and the weakness in manufacturing. Some of this weakness is believed to be linked to the Goods and Services Tax (GST), which Patel hopes may be resolved in the second half of the fiscal year. In line with these concerns, the RBI cut its fiscal year growth forecast from 7.3% to 6.7%.

Yet, while the growth forecast downgrade has been taken as a dovish signal by markets, we think that the linking of the slowdown to transitory effects suggests that for now the RBI is disinclined to cut rates further in support of growth.

Inflation remains well below the double digits of recent years, at 3.4%, but has risen sharply since a June low of 1.5%. Further rises are expected by the central bank, with the possibility of fiscal slippages highlighted by governor Patel.

He reiterated the commitment of the central bank to an inflation target of around 4%, which leaves limited space for further cuts at present. There will be concerns around the inflationary effects of higher oil prices, government policies on public sector pay, and the recent implementation of the GST.  As a positive, the RBI did say that household inflation expectations are becoming anchored, which is key to long-term inflation targeting.

Overall, we read today’s announcement and briefing as indicative of a central bank on hold for the next six months. The minutes, to be released later this month, may suggest otherwise, but for now the central bank seems content to wait and see whether data supports its view that the growth slowdown is temporary.