One doesn’t need to be a soothsayer to predict that the Reserve Bank of India (RBI) will keep the repo rate unchanged at the meeting of its monetary policy committee (MPC) on 4-5 April, the first such meeting in the new fiscal year. Any change in the stance of the monetary policy is also highly unlikely.
In its last review in February, the MPC left the policy rate unchanged at 6% and the stance remained neutral but the tone of the policy was cautious. It took the decision in favour of no-change in the repo rate with a 5-1 vote, with Michael D. Patra reiterating his call for a quarter percentage rate hike and others—Chetan Ghate, Pami Dua, Ravindra H. Dholakia, Viral V. Acharya and Urjit R. Patel—voting for status quo. I will not be surprised if it turns out to be a unanimous decision this time.
The February meeting took place against the backdrop of fiscal slippages, rising oil prices, shooting US treasury yields and pressure on inflation. Since then, there have been more causes for concerns on the external front but the good news is inflation has been undershooting the RBI’s projections and the Indian economy is on a recovery path. In February, the MPC left the rate untouched as it felt that “the nascent recovery" needed to be “carefully nurtured" and growth should be “put on a sustainably higher path through conducive and stable macro-financial management". Lower than projected retail inflation is likely to reinforce the belief. At least till June, RBI is unlikely to tinker with either the policy rate or its stance.
In February, RBI raised the inflation projection from 4.3-4.7% in the second half of FY2018, to 5.1% in the January-March quarter. For the first half of 2019, inflation has been projected at 5.1-5.3% but for the second half of 2019, it is sharply lower—at 4.5-4.6%. This is on account of strong favourable base effects and a likely softness in food inflation, assuming a normal monsoon and the government taking care of supply-side management.
Against these projections, retail inflation in February moderated to a four-month low of 4.4% year-on-year from 5.1% in January and 5.2% in December, driven by lower food price inflation (3.3% in February, down from 4.7% in January). Indeed, the delayed seasonal drop in vegetable prices continued, but the drop in food price inflation was broad-based. Also, core retail inflation—or ex-food and fuel inflation—remained almost same in February at around 5.2%.
Most analysts expect inflation to average around 4.6% in January-March quarter, lower than the RBI’s projection, but its future course will depend on many factors including the base effect, price of crude oil, the impact of housing rent allowance increase by several state governments, a potentially higher minimum support price of farm produce and a hike in import tariffs on a few items, besides the trajectory of monsoon. On most of these, clarity will emerge at the earliest by August and hence any change in either the policy rate or RBI’s stance on the monetary policy is unlikely in the April and June meetings of MPC.
A relatively lower retail inflation in the past two months has been accompanied by higher industrial production, signalling economic recovery. Industrial growth rose to 7.5% year-on-year in January, after 7.1% in December, and a 25-month high of 8.8% in November. These figures are in stark contrast to the 2.5% average industrial production growth in the first half of 2018.
Importantly, the rise has been broad-based, with consumer durables growing at 8% after a year-and-a-quarter-long indifferent performance and capital goods growing in double digits, indicating a strong cyclical recovery even though there is no sign of private capital investment.
On the external front, a “hawkish" Bank of England has kept its policy rate unchanged at 0.5% at its last MPC meeting, while a “dovish" US Federal Reserve hiked the rate by 0.25 percentage points to 1.75%. The Fed statement has implied two more quarter-percentage point rate hikes this year, against widespread market expectations of three hikes. While both have been on expected lines, what has added a new dimension to the external sector is the trade war waged by the US. It will affect global growth that has already started showing signs of moderation. It could have an impact on the rupee; a rise in interest rate is a classical way of protecting the local currency.
If the trade war does not impact the rupee in a big way that could warrant a hike in policy rate to protect the currency, I will not be surprised if the Indian central bank holds on to the current repo rate through the most part of calendar year 2018, even though its stance may turn hawkish in the second half when inflation rises and economic growth gathers momentum. In its February review, the RBI pegged the gross value added or GVA growth for 2018-19 at 7.2% (in the range of 7.3-7.4% for the first half and 7.1-7.2% for the second half) with risks evenly balanced. It could be raised to 7.4% for the year. While no change in the policy rate and even the stance is a given, in the first review of a new fiscal year, RBI may focus on regulations, supervision and governance, relevant in its war against bad loans and rising incidents of fraud in Indian banking.
Happy birthday, RBI
On Sunday, RBI turned 83. Its 24th governor Urjit Patel’s speech on 14 March highlighted the inadequacy of the central bank’s regulatory powers that are not ownership-neutral. He also spoke about dual regulation—by the RBI as well as the finance ministry, representing the government, the majority owner of 70% of Indian banking system.
Patel’s speech adds a new dimension to the debate on RBI’s autonomy, which is as old as the central bank itself. The history of central banking in India is replete with fights between RBI and the finance ministry, overt and covert. The title of the book by former governor D. Subbarao Who Moved My Interest Rate? is a testimony to this. His predecessor Y.V. Reddy, too, was involved in similar fights, even though he downplayed the fights—terming them “creative tension".
Subbarao’s successor Raghuram Rajan put his foot down when the finance ministry in February 2014 wanted RBI to pay an interim dividend ahead of the end of its accounting year in an effort to bridge India’s fiscal deficit and stick to the estimated deficit target. Patel, too, did not pay interim dividend even though there was pressure from the government. In June 2017, all six members of MPC, including Patel, declined to meet the finance ministry ahead of a review meeting.
Almost all RBI governors have had their run-ins with the government. And, this will continue irrespective of which government is in power and who is India’s chief money manager. It could be worth listening to what former RBI governor I.G. Patel (1 December 1977 to 15 September 1982) had once said: “The governor … is a public servant with loyalty to the country and the Constitution—not just to a government in transit. And yet, he cannot behave as if every issue is of great import. He has to choose his ground and be discreet above all. Without offending the government, he can start a debate and steer the argument in a certain direction. His ultimate defence is democracy and the tradition of free debate."
In one of his speeches, Subbarao paraphrased this succinctly: “Don’t nitpick. Pick your battles. Once you have picked your battles, fight those battles valiantly."