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Business News/ Opinion / New regime, old thinking
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New regime, old thinking

The more important issue now is how this monetary policy pronouncement has set the ball rolling for the future direction of monetary policy

Photo: ReutersPremium
Photo: Reuters

Monetary policy decisions can sometimes be boring. Not this one though. There was much interest among various stakeholders on Tuesday’s policy pronouncement, mainly due to the new construct of the decision-making process, whereby a monetary policy committee (MPC) consisting of six members took a joint decision on rate changes for the first time in Indian monetary policy history.

Thus, irrespective of changes in the signalling device—the repo rate—the market was keen to understand the thinking process of the committee. Interestingly, for the first decision under the MPC, there was no discord and all members voted in favour of a cut of 25 basis points.

While all participants in the market were unanimous that the recent sharp fall in inflation will likely lead to more room for RBI to react with a repo rate cut, the difference in opinion was with respect to the timing. We ourselves had expected that RBI will cut in December and possibly one more time after that. However, the decision to advance the timing rests in the following statement—“sharp drop in inflation reflects a downward shift in momentum of food inflation—which holds the key to future inflation outcomes".

This clearly represents the thought process underlying the staff projections of RBI whereby it sees the near-term outlook for inflation having improved considerably, likely to be backed by the usual seasonal softening of food prices. This follows the downward shift with respect to pulses and vegetables prices seen over the last couple of months or so, which will be soon factored into household price expectations. Producers’ inflation expectations, which are more forward looking, also tend to indicate that there are fewer expectations of higher selling prices in the near future.

All this indicates there is now a better probability for the headline Consumer Price Index (CPI) inflation to remain contained in the near future. Importantly, RBI feels the structural policy changes of the government, its astute food management programme and the new policies on containing pressures on pulse prices should contribute to reducing price volatilities.

Despite all the above, RBI maintains some caution and indicates the upside risks to inflation are still valid, but the intensity is definitely lower than was being highlighted during the last couple of policy announcements. This is also evident in the RBI staff projections that indicate a 5% average retail inflation for Q3, but moving up to 5.3% in Q4. MPC did note the potential cost push pressures that might emerge, including that from the 7th Pay Commission award implications for house price inflation, the increase in the minimum wage costs that could also spill over onto the minimum support prices and, to some extent, could create a wage-price spiral.

The more important issue now is how this monetary policy pronouncement has set the ball rolling for the future direction of monetary policy. Important to remember is that we are now in an inflation-targeting monetary policy regime where anticipated future direction of inflation will be more crucial in assessing monetary policy direction, rather than month-to-month movement in inflation rates.

IDFC Bank’s own assessment on inflation indicates RBI could possibly still be over-estimating the trajectory going forward. As per our own assessment, retail headline inflation could average 4.2% for Q3 and 4.8% for Q4. In the event that inflation continues to undershoot RBI’s expectation, the December policy remains quite live for a further 25 basis points cut.

While RBI continues on its accommodative stance, it is likely to remain extremely data-dependant and also consistently factor in changes in the global conditions—such as event risks of the US presidential elections, the US Fed rate changes and the baseline expectations on oil prices, given that the oil producing nations are pushing for a reduction in output to hold up the prices. Thus, while the probability of a December rate cut is high, the future trajectory is likely an ongoing evaluation.

Indranil Pan is group chief economist at IDFC Bank Ltd. The views are personal.

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Published: 05 Oct 2016, 01:04 AM IST
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