Calibrated tightening stance a surprise; rate cut likely in February

The credit policy has thrown some surprises as usual. While no change in repo and the cash reserve ratio (CRR) could still be justified, retention of the stance of ‘calibrated tightening’ at a stage when the inflation forecast for the second half has come down to 2.7 - 3.2 per cent does require some explanation. The upside risk to inflation today is from oil prices increasing or the state fiscal deficits slipping up. While one is sure, the other is not. 

Further, the MPC has highlighted the state Pay Commission impact which through real, may not be entering the HRA component which is expected to show lower increases given the high base effect dwindling. There are risks to rabi crop which can be a negative for prices too as area under sowing is not satisfactory so far. However the fact that MSPs have not quite delivered is a positive for inflation which has kept prices benign. It could be that the RBI would like to wait and watch before changing the stance.

On growth the policy is conservative and while retaining the target at 7.4 per cent has put a downside risk caveat. This really means that if any of the sectors that have fostered growth do not maintain the tempo, there can be some slippage. One can add here that the exact impact of liquidity on growth is yet to be ascertained as Q3 will incorporate these disturbances.

The big surprise in the tone is that while risks have been highlighted in terms of inflation in general and other global factors, liquidity does not find any mention. Quite clearly the RBI does not think that liquidity in terms of availability at the system level is serious as it has taken steps to ensure that the repo and OMO windows provide what is required. Issues of willingness to lend are anyway beyond its purview. But the fact that the growth process has not been impacted significantly as per the policy statement is a key takeaway.

In the development agenda, there is mention of SLR reduction to 18 per cent in a phased manner of six quarters, which is positive for the system. It has been linked with the LCR and hence not as much as a liquidity enhancing measure. This is positive for the banks from the point of view of liquidity management, though will not free resources as the present average SLR is around 28 per cent.

What does the future look like? With a low inflation projection, which looks unlikely to be derailed by anything significant as oil prices though expected to rise is not going to go back to the eighties, rate hikes can be ruled out. A possibility of a rate cut is there but will be largely data driven, as presently the risks that have been highlighted seem to outweigh the downside factors. While one may expect the February policy to bring about a rate cut, it will depend on the next two inflation numbers, where the November one is likely to be benign given the base impact. But with the status quo prevailing, one can still expect the tone to change; hence the stance would be made neutral if nothing untoward happens.

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The author is chief economist at CARE Ratings. Views are personal