RBI credit policy: Some misses on commentary, but MPC's decision on key rates was on expected lines

The Reserve Bank of India (RBI) credit policy has been on expected lines but could be a disappointment from the point of view of an absence of commentary on issues that were expected to be taken up. First is the NPA crisis and the exact position of the banking system today in light of all the accompanying controversies relating to governance and audit. The second is a view on FPI limits in debt that was expected by the markets, given that interest rates are rising in the west and there was need for these limits to be enhanced at home. The third is the possible pressure on liquidity in the second-half of the year on account of the higher borrowing programme of the government. The RBI could have given its view or assured the market of support through the injection of liquidity if required.

The Policy has tread the known path and spoken much on GDP growth and inflation. Growth is expected to be higher in FY 2018-19 but in the range of 7.4 percent which is an improvement over last year, but still below the high numbers the economy was used to earlier. Therefore, a gradual improvement is what we can expect this year and while the RBI is banking on investment, one can guess that it would still be the central government driving the same with some limited support from the private sector. The areas of growth have not been mentioned and it is hence inferred that it would be driven by specific sectors and not be broad-based.

 RBI credit policy: Some misses on commentary, but MPCs decision on key rates was on expected lines

The RBI headquarters in Mumbai. Reuters.

The inflation numbers and projections are interesting. The RBI has lowered its expectations on inflation to 4.7-5.1 percent for the first-half from 5.1-5.6 percent. This change of view is more due to the cooling of prices of food products and the gradual declining effect of the house rent component. The recent SKYMET forecast on the monsoons must have supported the view that inflation would be lower in the first-half of the year.

There could however be a different view on inflation on three counts. First, the oil situation, as the increase in prices of fuel products in the country have been very sharp and beyond our control, considering that the government is not willing to relent in terms of lowering duties or increasing the subsidy on these products. This will be a risk factor during the year as the first three months of the calendar year have been fairly volatile.

Second, the RBI also does not see MSP as a major threat because these prices would be announced before the sowing season, and given the political and emotive compulsions there would be a tendency for a major step-up in these prices in an aggressive manner with states too providing bonuses in a pre-election year. This would be another major risk to inflation forecasts this year.

Third, the non-food component of CPI inflation has been rigid in the plus five percent range and hence taking a number of less than five percent for the headline number would be premised a lot on food prices coming down very sharply, which is contrary to the MSP policy being pursued by the government. Therefore, there could be some revision in the inflation number in the coming months or policies.

What looks likely to be the path on policy rates? Presently it is clear that the RBI will not be increasing rates any time soon and with lower forecasts being made on inflation, there is reason to believe that there would be no rate cut unless conditions change drastically. But will rates be lowered during the year? Here the answer is that it would be data driven and notwithstanding which component moves the headline number the RBI should lower rates in case the number comes down below four percent, which is not expected presently. The view here is that a precondition to lowering interest rates will be core inflation coming down. This will be difficult given the HR component in the index which is being driven by both the central and state pay commission recommendations.

Further, a factor that has not found mention in the policy is the rise in the price of manufactured goods. The WPI index has shown an increase, albeit a gradual one, in the prices of manufactured products. This will continue to progress in the same line as the world economy recovers and global commodity prices increase. This helps the corporate sector to regain its pricing power. While the impact is more on WPI, it would also get reflected in prices of the core products in the CPI and hence poses an upside risk.

While a lower inflationary view is good for corporates, a sit means no increase in interest rates, and households will continue to be in a dilemma on where to invest their savings. Last year, mutual funds especially equity funds dominated the choice list as options were limited. Now with the long-term capital gains (LTCG) tax and unchanged rates, the mutual funds industry may become less attractive. However the choice of bank deposits may still be less attractive and it would be interesting to see how financial savings get deployed.

What is one to look for now? The next policy meeting too could be benign as nothing much is expected in the next two months. The progress of the monsoon and a clearer picture on crude oil would be the clues for both inflation and policy – which will take shape by August.

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Updated Date: Apr 05, 2018 19:43:15 IST