In RBI rate cut play, the US Fed is secondary

Seldom are all the chips in place for monetary policy but, for now, it seems the stage is set for a rate cut in February. Fed’s hawkishness may just turn out to be incidental


RBI is likely to prune its repo rate in February by a quarter percentage point, and the monetary policy committee, or MPC, will be only too happy to vote unanimously again. Photo: Aniruddha Chowdhury/Mint
RBI is likely to prune its repo rate in February by a quarter percentage point, and the monetary policy committee, or MPC, will be only too happy to vote unanimously again. Photo: Aniruddha Chowdhury/Mint

The change in the US Federal Reserve’s dot plots that now suggest more rate hikes in 2017 doesn’t seem to have made any material change to the Reserve Bank of India’s (RBI) monetary policy canvas.

Analysts still expect RBI to prune its repo rate in February by a quarter percentage point, and the monetary policy committee (MPC) will be only too happy to vote unanimously again.

Such expectations are not misplaced as the repercussions of the currency withdrawal on the domestic economy are still emerging and, given the scale of the monetary shock, a policy rate cut will not look out of place.

Growth is expected to get hit in the second half of 2016-17 as consumers bereft of cash curtail their spending. The tentative signs of this were seen in the purchasing managers’ index data for November which sank below 50, indicating a contraction.

Though growth would be an important factor in the MPC’s deliberations, the overriding element for RBI at every policy meet will be the flexible inflation target of 2-6%.

Here too, there seems to be only good news.

The headline retail inflation was 3.63% in October, lower than the central bank’s medium-term target of 4%, and the odds are that it will undershoot the 5% target for March. This is where the Fed’s future hikes will come to play.

One channel through which they queer the pitch for RBI is capital flows.

As dollar assets begin to generate more returns, a flight of capital from the emerging markets to the US is inevitable.

Dollars have started to leave India already, and the pace could continue next year as well. The immediate fallout is a depreciating currency, something that India can ill-afford when global crude oil prices have begun to climb.

India being a net importer, the implications of a weakening currency, along with rising oil prices, on inflation should not be overlooked. Recall that a falling rupee in fiscal 2012 and elevated crude oil prices ensured inflation became more entrenched in the following years.

But so far, these trends are not really alarming. To start with, the rupee is expected to depreciate at worst by about 2% in 2017. With forex reserves beefed up, RBI can intervene in the market, too, and contain the rupee’s fall.

Seldom are all the chips in place for monetary policy; but for now it seems the stage is set for a rate cut in February. The Fed’s hawkishness may just turn out to be incidental.

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