Going Beyond Policy Statement, Reserve Bank Gives Guidance


The fifth bi-monthly monetary policy statement of the Reserve Bank of India (RBI) had no surprise as the central bank’ action — or, the lack of it — has been on the expected line but going beyond the statement, for the first time, Governor Urjit Patel and Deputy Governor Viral Acharya have given guidance to the markets.

At the post-policy interaction with the media, Patel has said if the upside risks to inflation do not materialise, there is a possibility of space opening up for appropriate RBI action. This clearly means that the Indian central bank is not ruling out a change in stance (to neural) or even a rate cut.

Can that happen in the next meeting of the monetary policy committee in the first week of February 2019? It’s difficult to say at this point but it cannot be ruled out if both the food inflation and crude prices remain low.

If this is music to the ears of the equity market, bond dealers can take heart from Acharya’s comment that the RBI will continue to infuse liquidity in the system by buying bonds under the so-called open-market operation, or OMO. The RBI injected ~360 billion in October and ~500 billion in November through OMOs, taking the liquidity injection to ~1.36 trillion for the current fiscal year.

Acharya said the bond buying will continue till March to tackle any shortage of liquidity in the system. The yield on 10-year government security dropped below 7.5 per cent to touch 7.42 per cent, its eight-month low, following his clarification. Nobody could have asked for more.

For the record, the monetary policy committee (MPC) decided to keep the policy rate unchanged at 6.5 per cent and maintain the stance of calibrated tightening. The decision on a no-change policy rate was unanimous, while one of the six members of the MPC, Ravindra Dholakia, voted in favour of changing the stance to neutral.

On the expected line, the inflation projection has been revised downwards.

In the October policy, the retail inflation was projected at 4 per cent in second quarter and 3.9-4.5 per cent in the second half of 2019, and 4.8 per cent in the first quarter of 2020, with upside risks. The actual inflation outcome in the second quarter was 3.9 per cent and in October it dropped to 3.3 per cent.

Against this backdrop, the RBI’s new inflation projections are: 2.7-3.2 per cent in the second half of 2019 and 3.8-4.2 per cent in the first half of 2020, with upside risks. The RBI’s commitment is to achieve a medium-term target of 4 per cent retail inflation on a durable basis within a band of plus or minus 2 per cent, while supporting growth.

Why has the RBI not changed its stance despite lowering its inflation projection? Simply because the benign outlook for headline inflation is driven mainly by the unexpected softening of food inflation and collapse in oil prices in a relatively short period of time. Excluding food items, inflation has remained sticky and elevated, and, more importantly, “the output gap remains virtually closed”.

At the time of excessive volatility, we may have to stop thinking in terms of an interest rate cycle. Probably, the time has come where the central bank’s policy stance should remain neutral, allowing it the flexibility to hike or pare the rate, depending on the incoming data — something which the RBI had maintained till its October policy.

Although the growth in gross domestic product (GDP) slowed down to 7.1 per cent year-on-year in the second quarter of 2019, after four consecutive quarters of acceleration, and sharply down from 8.2 per cent in the first quarter, the RBI does not seem to be perturbed about it.

It has cited multiple indicators to explain that the growth story is intact in the Indian economy. For instance, the gross fixed capital formation expanded by double digits for the third consecutive quarter; the purchasing managers’ index for manufacturing touched an 11-month high of 54 in November; and, going by the assessment of the RBI’s latest Industrial Outlook Survey, the overall business sentiment in the third quarter is stable, with sustained optimism about production and exports.

Besides, investment activities have been on the rise and the banking sector’s credit off-take has crossed 15 per cent, more than the nominal GDP growth. So, there is no change in the RBI’s projection of 7.4 per cent GDP growth rate in 2019 and 7.5 per cent in the first half of 2020, with downside risks.

Of coursethe RBI’s bullishness on growth is laced with a caveat — while the acceleration in investment activity bodes well for the medium-term growth potential of the economy, fiscal discipline is critical to create space for and crowd in private investment activity.

Besides, fiscal slippages will also influence the inflation outlook. India’s fiscal deficit breached the budgeted target for financial year 2018-19 in October.

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