August RBI MPC preview: Prudence lies in pause

Research evidence excerpt

August RBI MPC preview: Prudence lies in pause

banks have reportedly mobilised nearly

USD32bn, largely through FCNR(B) deposits, while government securities have attracted more

than USD7bn of foreign inflows. At a time when worries about the oil price rebound have

revived fears about India's import bill, this pace of foreign capital inflow is a significant

tailwind. As these measures work their way into the balance of payments and domestic

liquidity conditions, we expect the RBI to wait to assess their effect before commencing the

hiking cycle.

It is a difficult backdrop. Re-escalation risks remain. El Niño could intensify. Inflation

prints are rising. Oil could rebound again. The environment facing the MPC is no less

challenging today than it was in June. The difference is that, unlike then, foreign inflows

have improved at the margin, erasing the tail risk for the currency. This should allow the

MPC to remain on pause at the upcoming 5 August meeting.

Indicator of financial conditions: Back to square one

India's financial conditions have tightened over the past week and are in line with where

they were at the time of the June MPC meeting, as the Middle East re-escalation and

consequent surge in oil prices outweighed the effect of policy announcements on 5 June.

Our indicator of financial conditions (FCI) was 1.4 as of 24 July, similar to the 1.5 reading

as off 5 June, and higher than our previous FCI update (21 May: 1.0). (A zero reading

indicates neutral conditions, above zero indicates conditions are tighter than the historical

decadal average, and vice versa.)

The policy decision on 5 June and the capital flow measures announced in collaboration with

the MoF sparked a relief rally on short-end rates and INR. This was followed by a signing of the