The lack of action in the Reserve Bank of India’s (RBI) sixth bimonthly monetary policy on Wednesday is no surprise; an ounce of surprise is the change in the stance of the policy—from accommodative to neutral.
Analysts of banks and fund houses who were pencilling in a 25 to 50 basis points rate cut between now and December 2017 will have to go back to the drawing board and work on their predictions. The status quo in this policy has not postponed the next rate cut, it has shelved it. One basis point is a hundredth of a percentage point.
The easy money regime which started in January 2015 with a 25 basis points policy rate cut to 7.75% is over. In the most optimistic scenario, the earliest that the next rate cut can happen—if, at all—is in August after the Indian central bank gets a grip on the trajectory of the monsoon and food prices and clarity emerges on external factors such as the price of crude and internally, the impact of a rise in house rent allowances of central government employees.
By emphasizing its determination to bring down inflation closer to 4% on a durable basis and focus on macroeconomic stability, the RBI has restored its credibility, which many felt the Indian central bank was losing.
Since January 2015, the RBI has cut its policy rate by 175 basis points to 6.25%. The biggest push for yet another rate cut at this point has been a sharp drop in retail inflation. It dropped to 3.41% in December from 3.63% in the previous month—its lowest since November 2014. However, the six-member monetary policy committee or MPC downplayed this while taking a call on the policy rate and focussed on the upward risks to inflation. The drop in inflation has been primarily driven by deflation in the prices of vegetables and pulses and excluding food and fuel, inflation remained sticky at 4.9% for four months at a stretch, since September. Among others, a rise in international crude prices has contributed to this. The MPC did not want to take any chances.
The process started in December when the central bank took a call against a rate cut, going against the consensus estimate, and culminated in the current policy which not only maintained status quo on the rate front but also changed the stance of the policy.
In the fifth bimonthly policy in December, the RBI projected inflation at 5% by March 2017 with risks lower than earlier but still tilted towards the upside. This time around, its statement says that inflation is likely to remain below 5% in March but is expected to gather momentum afterwards when economic growth picks up. The so-called base effect will reverse and, in fact, turn adverse in the second half of fiscal year 2018. This is why RBI has kept its inflation target in the range of 4-4.5% in the first half of the financial year and 4.5-5% in the second of 2017 with risks “evenly balanced”. Three significant upside risks to the projected inflation path are rising international crude prices, volatility in the exchange rate on account of global financial market developments, and the fuller effects of the house rent allowances under the 7th Central Pay Commission award.
A cautious RBI has projected growth at 6.9% in 2017 with risks “evenly balanced” but expects a bounce in 2018 on account of several factors, including a rise in discretionary consumer demand and better transmission of monetary policy post-demonetization. Flush with liquidity, many banks have cut their benchmark marginal cost of funds-based lending rates by as much as 90 basis points. The 2018 growth has been projected at 7.4%. Even though the stance of the monetary policy has changed, if the liquidity in the system remains “appropriate”, which the RBI has committed to maintain using “all instruments at its command”, loan rates are unlikely to harden fast. They could remain at the current low levels for a longer time if the banks decide to pare their deposit rates.
Many felt that RBI would go for another round of rate cuts (if not now, in April) before the announcement of the monetary policy. By not doing so, the central bank has surprised the market once again.
No wonder that the 10-year bond yield rose 31 basis points, the most in more than three years. Another interesting factoid is that all six members of MPC have read the tea leaves the same way in all three policy meetings they have attended so far.
Tamal Bandyopadhyay, consulting editor at Mint, is adviser to Bandhan Bank. He is also the author of A Bank for the Buck, Sahara: The Untold Story and Bandhan: The Making of a Bank.
His Twitter handle is @tamalbandyo.
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