Three key takeaways from the RBI's policy review

The Reserve Bank of India (RBI) kept its key interest rate unchanged at 6 per cent for the fourth time in succession at its final bi-monthly monetary policy review of the fiscal, citing concerns about the inflationary push by rising global crude oil prices. The author looks at the rationale behind the RBI's decision to maintain a neutral stance in its monetary policy review.

There are three main takeaways from the credit policy that was presented today. First is that the RBI is broadly in consonance with the Economic Survey with regards to growth. While GVA growth for FY18 has been put at 6.6%, it would broadly amount to around 6.7-6.8% growth in GDP for this year. Also heartening is the fact that its projection for FY19 at 7.2% would also mean GDP growth in the region of just less than 7.5%. At any rate, this would be an improvement for the economy. More importantly, the RBI has pointed out that the recap of banks will help in fostering investment as banks would be better equipped to lend now. 

The second highlight is the view on inflation. There is an acceptance that higher inflation is here to stay with us which means that the number of 5.1% projected for Q4 would actually move upwards in H1-FY19 to the region of 5.1-5.6% before retreating to 4.5-4.6% in H2-0FY19 provided monsoon is good as the base effects come into play. The policy has rightly pointed to the importance of the Budget in this number. It has brought to the fore the fiscal deficit and borrowing programme which can lead to higher demand pull forces. The fact that there was slippage last year means that ti cannot be ruled out this time too. More importantly, the increase in customs rates on several goods as well as the proposed hike in MSP would lead to cost-push inflation. This is where the government comes in. The Budget has been agnostic to price support in the downward direction of fuel products which can be gauged by the unchanged fuel subsidy as well as higher duty collections on fuel products. Now, if the oil price remains elevated a tough call has to be taken whether or not to provide the extra subsidy or cut duty rates to quell inflation. The ball would be in the government’s court.

The third interesting takeaway in the policy is the indication that while a neutral view has been taken, the upward trajectory of inflation can be interpreted in two ways. The first is that for the first half of the year, with CPI at 5.1-5.6% there is definitely no possibility of a rate cut. Further, if this number is breached there could be a rate hike instead to ensure that inflation is under control. 

Curiously, this time no member has voted for a rate cut, which is significant as there have been calls seen in the past for a rate cut by a certain section of the committee. In retrospect, the majority stance does stand vindicated as the MPC has unanimously raised its projections on inflation. 

The RBI also is cognizant of the rather tardy transmission mechanism of rate actions to the customer and hence has spoken of linking the base rate with the MCLR, where the latter is more responsive to policy changes. This would help considerably in terms of transmission and make the system more efficient.

Contrary to expectations, the RBI has not spoken on current liquidity and GSec yields but has given indications that it would be ensuring that there is never a liquidity crunch through its own actions of reverse repo/repo and OMOs. This should be assuring the markets. 

In the development part of the policy, there is mention of the FBIL (Financial benchmarks India Limited) taking control of bond valuation and currency rates besides MIBOR. A question is whether this will mean FIMMDA going in for some re-invention? 

Madan Sabnavis is Chief Economist, CARE Ratings. Views are personal