RBI keeps policy rate unchanged: When will the Monetary Policy Committee pull the trigger next?

At a time when the economy is going through tough times with a declining rupee, tight liquidity, rising interest rates, prospective inflation and general apprehension a lot was expected from the monetary policy. In hindsight, this may have been unrealistic as the Monetary Policy Committee (MPC) has been clearly mandated to address just one issue: i.e. CPI inflation.

It was logical to expect a rate hike which would have first acted as a pre-emptive move to fight inflation. Wasn’t this the case the last two times when the inflation rate was well within the targeted zone and yet the repo rate was raised?

Also, given that the Federal Reserve has increased rates and indicated more such hikes and the fact that Foreign Portfolio Investor (FPI) flows are negative to India, a rate hike would have served the dual process of retaining such investment. But this was not to be. The Reserve Bank of India (RBI) has made some definite indications in its policy. First, there is no need to increase interest rates presently as it is not necessary to do so every time it is announced. [caption id=“attachment_4095761” align=“alignleft” width=“380”] File image of RBI Governor Urjit Patel. AFP.[/caption] Second, it expects inflation to come down and hence has revised its projections for Q2 and H2 of FY19. Third, it sees a lot of growth opportunity in the economy as evidenced by the improvement in capacity utilisation. This supports its belief that GDP growth will be 7.4 percent this year. Fourth, it is cognizant of the inflationary pressures which are in the economy that are in three areas. First, the Minimum Support Price (MSP) issue of food prices increasing once they get real. Second, crude oil prices are spiraling and can be a threat if not checked. The government’s move to lower duties was an attempt to do though admittedly cannot be a continuous policy. Third, input costs have increased due to global and domestic factors that can upset the inflation numbers and is already seen in the WPI inflation. But, on balance, the MPC agrees that the tendency will be for headline inflation to be within their projected range of 3.9-4.5 percent for the second half of the year. And in case it does not, then there would be further increases in interest rates. And this is why a new concept has been introduced on the stance taken by the MPC which is ‘calibrated tightening’. Inflation forecasting is always challenging because things change regularly and single components of the index can turn things around. The MPC is evidently convinced that inflation will actually come down and here one suspects that it is looking at it more statistically where the high base effect would keep the number down. Therefore, the overt incidence of high inflation in the form of oil and other inputs gets overwhelmed by the base effects of other items, especially house rent. A pertinent question which is actually a puzzle in forming expectation on credit policy is, when does the MPC pull the trigger? In the June Policy, the number of 4.6 percent was available while in August the inflation number was 5 percent while for October it was 3.7 percent. All the three numbers were within the band of 2 percent above 4 percent benchmark. Also it is understood that the high base effect will work its way for the next couple of months too. When does the RBI action become a rate hike or when does the central bank decide to leave things as they are? And the present time period has been the most volatile one with crude oil prices rising by over $ 10/barrel and the currency has slipped by over Rs 5/$. This leads to the other issue on currency. Another reason for expecting a rate hike was to help to stem the FPI outflows. Over $2.8 billion flowed out in September. With a weak rupee and relatively lower return in domestic markets, FPIs would further withdraw from the country which will exacerbate the currency rate further. A rate hike would help to slowdown the outflow and encourage inflows at a point of time. Given that the government had announced measures to hasten these flows, keeping interest rates untouched would remove the rate of return advantage vis a vis the western markets.

The other concern of the market was liquidity which could have been assuaged by a cash reserve ratio (CRR) cut.

From the tone of the statement, it appears that first the liquidity shortage is only transient and would even out in course of time. Further, if at all there were strains, they would be evened out through Open Market Operation (OMO) flows. Against these interpretations, can one look into the future and guess how the rate environment would like for the rest of the year. The answer is no because it is getting hard to interpret the RBI’s action when objective numbers look similar but subjective view of environment different. In fact, in the earlier two policies when rates were increased, the inflation numbers looked okay and the environment positive in terms of low crude prices and stable currency. Yet there were two successive rate hikes. Now the inflation numbers look a bit better, but the environment negative. As the policy goes with a stance of calibrated strengthening one can guess that there can be another rate hike when price conditions turn adverse. Till then it will be status quo, and the currency will be market-driven and liquidity supported by OMOs. (The writer is Chief Economist, CARE Ratings; and author of Economics of India: How to fool all people for all times)