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Reserve Bank of India monetary policy tomorrow: Why Urjit Patel will be watched beyond interest rates

Tuesday’s monetary policy announcement will be marked in history as the first meet where the interest rate decision is taken by a panel, and not by an individual—-the Reserve Bank of India (RBI) governor. Urjit Patel, the new RBI chief, will be one among the six-member Monetary Policy Committee (MPC) notified by the government last week under the Reserve Bank of India Act, 1934. The governor, of course, will have a key role in the whole process and a casting vote in case there is a tie. But, beyond that, the RBI governor wouldn’t have the stardom, he typically enjoys during bi-monthly monetary policy meets. It isn’t a one-man show anymore.

Urjit Patel, RBI governor. Courtesy: Patel's Twitter handle

Urjit Patel, RBI governor. Courtesy: Patel's Twitter handle

In the 6-member panel, the Narendra Modi Government has chosen well the three members from its side to not give room for theories that it is hijacking the monetary policy. One of the members, Indian Statistical Institute Professor, Chetan Ghate, appears to be backing an inflation-centred policy approach considering his past work. Ravindra H Dholakia, a professor at Indian Institute of Management, Ahmedabad isn‘t seen as a firm believer in inflation-focused monetary policy and Pami Dua, Delhi School Economics Director, is not known to have a certain leniency to any particular policy model. Hence, largely, there is no known uniform pattern in the thought-process of government’s three nominees on monetary policy.

On the central bank’s side, besides governor Patel (who is the chief architect of the inflation-focused monetary policy while he was a deputy to his predecessor, former RBI governor Raghuram Rajan), the other two members are one of the current deputy govenors, R Gandhi and one of the executive directors, Micheal Patra. Again, there aren’t many clues that offer their stance on interest rates. Going by the indications on the retail inflation-front and the economy, the MPC would choose to cut the key policy rate, repo, at which the RBI lends short-term funds to banks by 25-50 basis points (bps) between now and December. One bps is one hundredth of a percentage point. The question is when.

Since January, 2015, the RBI has cut the repo rate by a cumulative 150 bps. The rate currently stands at 6.5 percent. The Consumer Price Inflation (CPI) trajectory, gives one strong reason to expect a rate cut at the earliest. At the last reading (in August), the CPI inflation fell to 5.05 percent compared with 6.07 percent in July. The RBI has a March, 2017 target of 5 percent inflation target. Most economists believe that inflation might well fall below that level during this period given that monsoons this year has been favourable and farmers are indicating good crop output. Food price inflation, the main villain in the inflation story, has eased considerably in the recent past.

As Firstpost noted in an earlier article, the advance estimate released by the agriculture minister this year suggests that country’s food grain production will rise by 9 percent to an all-time high of 135.03 million tonnes in the kharif season of 2016-17 on record output of rice and pulses following a good monsoon. Food grain production stood at 124.01 million tonnes (MT) in the kharif season of 2015-16 crop year (July-June). If these forecasts come true, it will help to further soften the retail prices, which have remained a major factor fuelling high inflation.

But, there are upside risks for inflation too.

The central bank has been worried about certain factors including the 7th Pay Commission pay hike impact on broader inflation, unseasonal rains that could impact farming in certain parts of the country, the looming rate hike from the US Federal reserve, expected by end of this year and the pressure on the money markets on account of the impending FCNRB redemptions.

“Risks to the inflation target of 5 percent for March 2017 continue to be on the upside. Furthermore, while the direct statistical effect of house rent allowances under the 7th CPC’s (central pay commission) award may be looked through, its impact on inflation expectations will have to be carefully monitored so as to pre-empt a generalisation of inflation pressures. In terms of immediate outcomes, much will depend on the benign effects of the monsoon on food prices,” said the central bank in the 9 August monetary policy. If these concerns are acknowledged by the MPC, it might put off the rate cut plan to December and choose to hold rate tomorrow.

Besides technical and economic factors, there is political pressure slowly building upon the central bank to cut rates. There have been signs of this in the recent past, ranging from Commerce Minister, Nirmala Sitharaman’s call for 200 bps rate cut to save small industries to Finance Minister, Arun Jaitley’s hope that the MPC will keep ‘all factors in mind’ when it sits down to formulate monetary policy on 4 October.

The RBI will have to take into consideration what the government thinks on rate cuts. A rate cut is sure between now and December. The question is will the MPC go for the market-bonanza in its inaugural meet on Tuesday or in December.

Beyond rate cuts, what is also important to watch is the statement from governor Patel, who prefers to call the central bank an ‘owl’, on central bank’s future stance on various issues, particularly on the ongoing bad loan clean-up process.

Updated Date: Oct 03, 2016 14:46 PM

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