Monetary policy best works on unanticipated surprises and possibly this reflects the hallmark of today’s Reserve Bank of India (RBI) policy announcement. In effect, the RBI decision to keep the policy rate unchanged, while changing the stance to “calibrated tightening" is a well thought-out move on two counts. First, at the theoretical level any policy decision to counter volatility in foreign exchange would have sent out wrong signals.

Practical consideration shows that interest rate by itself cannot contain volatility in exchange rates, as we witnessed in 2013, when the currency had continued to depreciate till a FCNR (foreign currency non-resident) deposit scheme was unveiled. In fact, RBI research shows that emerging market currencies depreciate following an energy price shock (as is happening currently) and the impact is seen to be stronger in the post global financial crisis period.

Also the extent of depreciation is clearly linked to domestic energy requirements. Interestingly, RBI research further shows that such volatility in currency value reaches a peak in the third month and tapers off thereafter. With the Indian foreign currency market witness to disturbance from July onwards, possibly the volatility may have therefore peaked as of now. Second, the increasing uncertainty in global markets, possible weakening in global trade prospects and financial stability consideration indicated that pause was the best option as the signal-to-noise ratio is now low and a policy change may not have been effective.

Coming to the specifics of the policy, RBI growth projections reveal a secular decline in quarterly growth forecasts from 8.2% in Q1 to 7.1% in Q4 of current fiscal. Growth is likely to be impacted in a hostile global environment through trade wars and US policy normalization, among others. The inflation assessment appears to be indicating a possible acceleration in the future due to rise in input cost and rising pricing power. However, RBI is also overtly surprised that “a broad-based uptick in inflation in respect of prices of fuel, transportation, personal care/effects, education and health services was largely offset by the unexpectedly and unseasonally benign food inflation". According to RBI projection, inflation in Q4 will be at 4.5% and even for Q1FY20, inflation will stay below 5%.

The tightening in domestic and international financial conditions (after the Fed rate hike) may dampen the domestic investment environment at a time when capital formation has surged to a nine quarter high also suggest that a rate hike was not warranted at this stage and it is best to wait for the earlier two rate hikes to work through the system with a lag.

The RBI has also emphasized that liquidity conditions would continue to be managed consistently with the stated policy objective of aligning the weighted average call rate with the policy repo rate and ensuring durable liquidity conditions are just met.

For the record, net repo liquidity is currently is in a surplus mode. The market has also taken positively the RBI proactive measure of announcing an OMO (open market operation) calendar for the month of October in advance.

Perhaps the biggest surprise from the policy is that the policy statement is silent on the rupee. In the subsequent press interaction however the governor emphasized that being an inflation-targeting central bank, the apex bank is concerned about exchange rate only to the extent that it feeds into imported inflation.

Notwithstanding the theoretical considerations mentioned above, the only one place where the word occurs in the entire policy statement: “Tailwinds from the recent depreciation of the rupee could be muted by the slowing down of global trade and the escalating tariff war" suggest that a window of opportunity is available to capitalize of the opportunities arising out of trade wars.

This warrant a favourable policy accommodation for the tradable sector. For the financial system as a whole, the policy though has not unveiled too many measures, but clearly emphasizes that financial market players, including banks and non-banking financial companies (NBFCs) need to be vigilant on many fronts.

Rajnish Kumar is chairman, State Bank of India.