RBI policy: Will 2018 be a no rate cut year? Stage likely set for Modi govt-Urjit Patel face-off

The RBI is primarily mandated to target inflation. And that’s all it is going to do going ahead, despite the mounting pressure from the Narendra Modi-government to gift a rate cut to spur growth. Looking at the monetary policy document that appears to be a message from Urjit Patel and his team to the government. In any case, a status-quo in rates from the monetary policy committee (MPC) on Wednesday was never a surprise to the markets.

But, the more important point to note here is that the MPC may be beginning a phase of prolonged pause in the key rates for most part of 2018. This is because the central bank expects the inflation to remain within a range, albeit on the higher side.

File image of RBI Governor Urjit Patel. Reuters

File image of RBI Governor Urjit Patel. Reuters

Secondly, it expects the growth scenario to improve from now on. The dominant mood seems be caution. Hence, the ‘neutral stance’ and mention of future rate actions to incoming data. During the presser post policy announcement, RBI governor Urjit Patel said ‘neutral stance’ enables it to move either way depending on the incoming data. But, the policy document leaves enough clues to believe why the MPC may not be in a hurry anytime soon to cut the rates, perhaps not for another one year. The new inflation forecast for the second half of the fiscal year 2018 is 4.3 percent to 4.7 percent, not very different from the previous estimate (4.2-4.6 percent).

Understandably, the RBI is not willing to lower the guard and cut rates. Several risk factors have been cited for higher inflation. These include yet-to-be-reflected impact of HRA by the Central Government in the inflation. The RBI expects that the staggered impact of HRA increases by various state governments may push up housing inflation further in 2018, with attendant second order effects. Also, with the crude inching up, there will be additional pressure on prices.

To assert its cautionary stance on inflation, the RBI has cited a recent survey of households which showed that inflation expectations have already firmed up and any increase in food and fuel prices may further harden these expectations. Further, rising input cost conditions point towards higher risk of pass-through to retail prices in the near term. Also, implementation of farm loan waivers by select states, partial roll back of excise duty and VAT in the case of petroleum products, and, finally, a decrease in revenue on account of reduction in GST rates for several goods and services may result in fiscal slippage with attendant implications for inflation. Besides all these, there are global risks and uncertainties too that may contribute to an up move in domestic inflation. Looking at these risk factors, one can safely say that the RBI is in no mood to go for a rate cut anytime soon.

The only thing that can alter central bank’s rate course is the growth scenario. If growth falters in a big way, there will be immense pressure on the rate setting panel to lower rates. But, the central bank doesn’t expect the slowdown to continue and sees signs of improvement and makes it case for better growth citing the following reasons: a) “capital raised from the primary capital market has increased significantly after several years of sluggish activity. As the capital raised is deployed to set up new projects, it will add to demand in the short run and boost the growth potential of the economy over the medium-term.” b) the improvement in the ease of doing business ranking should help sustain foreign direct investment in the economy. c) large distressed borrowers are being referenced to the insolvency and bankruptcy code (IBC) and public sector banks are being recapitalised, which should enhance allocative efficiency. Taking into account all these, the projection of real GVA growth for 2017-18 has been retained at 6.7 percent. This is in line with most estimates.

The short point is this: With persisting inflation risks, growth improving and with liquidity conditions largely comfortable in the banking system, the MPC may go on a pause mode for most part of the year 2018.

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Updated Date: Dec 06, 2017 18:10:19 IST

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