The run-up to this policy has been exceptionally uncertain with a variety of combinations of policy rates and cash reserve ratio (CRR) being tossed around. Unlike the more sedate pattern in the run-up to policy meetings of other central banks, market expectations of the Reserve Bank of India’s (RBI) policy moves have become a free for all, a pattern that only fuels more uncertainty, as the choice of tool, magnitude of change, and its timing (since RBI frequently moves inter-meeting as well) are all in play.
In the final tally, RBI chose to go with a measured 25 basis points (bps) hike across policy rates and CRR, which was less than what markets had finally priced in. Perhaps the markets had created a virtual reality of aggressive RBI response and then got jittery by their own creation. Still, the hawkish tone and sense of urgency in the March and April statements appear out of sync with the actual action that was undertaken each time.
GDP growth of 8.0% with upside risk and non-food loan growth of 20.0% are realistic, but Wholesale Price Index (WPI)-based inflation of 5.5% is slightly optimistic. Interestingly, RBI has stepped up its anti-inflation rhetoric just as there are some early signs of headline inflation nearing a peak, even though non-food inflation will continue to be affected by global commodity prices and local demand. Another factor effecting the inflation outlook will be the pace at which the government decides to deal with fuel-related subsidies, and the impact of the coming monsoon season. Unless there is a hit from global commodity prices, headline WPI inflation rate should soon begin to trend lower.
With the latest rate hike, RBI is closing the gap with its neutral rate, crudely estimated at around 4.25-4.50% on the reverse repo rate (repo rate should be 150 bps higher given the current width of the rate corridor). Depending on the monsoon outcome, RBI will likely increase rates again in the run-up to or at the July review, and then probably pause, unless economic growth or inflation (or both) upset calculations.
Monetary tightening: The Reserve Bank is closing the gap with its neutral rate, estimated at around 4.25-4.50% for the reverse repo. Adeel Halim/Bloomberg
RBI has been accused of being “behind the curve” as headline inflation has been higher than its forecast. This characterization would have been accurate if RBI were an inflation targeteer, or a central bank that was not constrained by other factors, such as ensuring the smooth passage of huge government borrowing. Also, the big swing in headline inflation was initially driven by food prices that were affected by last year’s drought and by the government’s own redistributive strategy that boosted purchasing power—outcomes over which RBI had little say.
Further, RBI’s multi-indicators approach suggests that the freely available “behind the curve” accusation cannot be applied fairly to it. It goes without saying that the pace of monetary normalization would have been different if policy was not constrained by government borrowing.
There are two main idiosyncrasies that plague RBI that should be addressed for better traction of monetary management. One, RBI is the only central bank that I am aware of that targets some form of input prices (i.e., wholesale prices) rather than consumer prices. RBI also tracks other inflation indicators, but it announces a formal forecast only for WPI inflation, which makes that indicator most relevant from the policy and market perspective. The government needs to come up with a more reliable inflation indicator.
Two, RBI has no qualms about frequently announcing inter-meeting monetary action, which in turn only compromises the significance of such moves. That practice is also at odds with that of most other central banks where inter-meeting moves are infrequent and are triggered by exceptional and unanticipated circumstances.
As India integrates more fully with the rest of the world, unanticipated global factors will have greater effect on monetary management.
RBI needs to have more frequent policy reviews than the current three-month cycle.
In the final tally, RBI has again delivered the goods as it continues with its handle-with-care normalization. However, while inflation concerns will persist for some time, there is another battle between capital inflows and rupee appreciation waiting in the wings. It is unclear how prepared the government is this time. Hopefully, old problems will not resurrect old solutions.
The author is head of India and Asean economics at Macquarie Capital Securities, Singapore. These are his personal views.
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