Handing over the baton: Sajjid Z Chinoy

The market frenzy that accompanies each monetary policy meeting was thankfully absent this time around. Having characterised the 50-basis point rate cut in September as a case of "front-loading," the Reserve Bank of India (RBI) was widely expected to be on hold mode. In fact, since the last review, there have been pockets of food price pressures domestically and globally, the momentum of core-core inflation has mean-reverted, fiscal uncertainties have arisen on the back of the proposed public sector wage hike, and a US Federal Reserve hike looms - all of which likely reinforced the central bank's desire to stay pat.

Going forward, RBI guided that it would closely follow commodity and food prices, external developments and the Budget, and stayed open to the possibility of more easing as long as it did not impede the five per cent inflation target for January 2017.

Conspicuous by its absence, however, was an over-emphasis on external risks related to the Fed rate hike cycle. What this suggests is RBI has growing conviction that the external sector - both the balance-of-payments and foreign currency reserves - have improved to the point that the impact of a global shock will not be so disorderly on the rupee, so as to derail the presumed stance of monetary policy. In other words, monetary policy will predominantly be dictated by domestic growth-inflation dynamics, rather than be influenced by any Fed-hiking cycle, which is materially different from the external constraints being imposed on other emerging markets by a Fed hiking cycle. This is no small feat. For an economy that had to raise short-terms rates by 300 basis points (bps) at the first hint of a tapering 2013, to be relatively oblivious of a Fed hiking cycle is testimony to the quantum of the macroeconomic adjustment that has taken place in the past two years, underpinned both by good policy (fiscal, monetary, and supply bottlenecks like coal) and a lot of good luck (oil and commodities).

But even so, the space for further easing appears very limited. Inflation is expected to average around 5.5 per cent in the January-March quarter, right at the upper end of the four to six per cent band that RBI will eventually be targeting. And this is despite a massive tailwind from global commodity disinflation and weak pricing power at home. What it suggests is there is a structural component to food inflation, inflation expectations remain suitably elevated (which is not surprising, given how sluggish and adaptive they are in most emerging markets), and there is no excess capacity in the non-tradable (services; infrastructure). For all these reasons any easing down the line, though possible, is likely to be very modest.

Instead, we need to start accepting the reality that the limits of monetary easing may have been reached. The onus on growth will need to fall disproportionately on the government. The good news is the slew of announcements by the government over the past month, and the fervour with which it is pursuing the goods and services tax Bill and a productive session of Parliament, suggests it is up to the challenge.

Sajjid Z Chinoy
Chief India Economist, J P Morgan