Decoding RBI Governor Rajan's policy: If all's well, rate cuts will begin by mid-March

Reserve Bank Governor Raghuram Rajan failed to live up to his reputation for surprises. He was expected not to cut interest rates in his fifth bi-monthly policy statement today (2 December), and (surprise, surprise) he didn’t. The repo is the same, the cash reserve ratio is the same, the money god is in heaven and all’s well in the world of predictable monetary policy.

Clearly, this Governor is not for turning.

But if India Inc wants to see hope and positive signals, it should read the fine print - especially the six paragraphs that talk of his ‘Policy stance and rationale’.

On inflation, the RBI is clearly looking more optimistic. Rajan said: “Risks from imported inflation appear to be retreating, given the softening of international commodity prices, especially crude, and reasonable stability in the foreign exchange market. Accordingly, the central forecast for CPI inflation is revised down to 6 per cent for March 2015.”

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Translation: Now, 6 percent is the target for January 2016. Rajan’s target is being achieved well ahead of schedule. The governor is saying that even though there are risks of inflation rising a bit due to a cereal price spike early next year after an expected kharif production shortfall, his March 2015 target is being revised downwards. The clear message: inflation is coming under control, even if it is partly due to favourable oil prices. He is only waiting to be sure.

Effective cost of credit is already coming down. Rajan said: “Some easing of monetary conditions has already taken place. The weighted average call rates as well as long term yields for government and high-quality corporate issuances have moderated substantially since end-August. However, these interest rate impulses have yet to be transmitted by banks into lower lending rates.”

Translation: This means only one thing: banks can lower interest rates if they want to. But possibly they are not doing so because of concerns over their bad loans. But Rajan is also subtly saying that interest rates are, if anything, south-bound.

The RBI does not want to send the “all is well” right now. This is what Rajan actually said: “Still weak demand and the rapid pace of recent disinflation are factors supporting monetary accommodation. However, the weak transmission by banks of the recent fall in money market rates into lending rates suggests monetary policy shifts will primarily have signaling effects for a while.”

Translation: In aam aadmi English, it means this. Even if the RBI cuts rates, it will only be a signal and symbolic in value, for banks may not cut rates as much. More important, Rajan does not think he should send too positive a signal right now and relax his guard.

Interest rates will probably come down “early next year”. Rajan’s exact words were this: “A change in the monetary policy stance at the current juncture is premature. However, if the current inflation momentum and changes in inflationary expectations continue, and fiscal developments are encouraging, a change in the monetary policy stance is likely early next year, including outside the policy review cycle.”

Translation: These are the most important words in the policy statement. They mean the following: if the December and January price data are fine, a rate cut could happen in March, or latest by April. It would help if Arun Jaitley presented a good budget where fiscal targets are met.

This is what the markets can bet on: if CPI inflation remains under 6 percent till February (figures due by the first fortnight of March), by mid-March or early April rates may be cut. Rajan may choose to surprise in March.