'Nimble footed monetary policy'

RBI governor announced bi-monthly monetary policy review on Tuesday, while maintaining status quo on policy rates. This was in line with market expectations, as inflation has come off to nine-month low. Additionally governor also ruled out a further tightening in the near term if inflation continued along the “glide path”.

However, Policy review recognises the fact that “excluding food and fuel, however, retail inflation remained sticky at around 8 percent. This suggests that some demand pressures are still at play”.

The policy highlights long list of risks to central forecast of no change in inflation –

• Stemming from a less-than-normal monsoon due to possible el nino effects;

• Uncertainty on the setting of minimum support prices for agricultural commodities and the setting of other administered prices, especially of fuel, fertiliser and electricity;
• The outlook for fiscal policy;
• Geo-political developments and their impact on international commodity prices

Going by wordings and spirit of the policy, we think the tone was one of caution, emphasising the potential upside pressures on retail inflation. In fact, we think today’s move of reducing banks’ LAF repo borrowing limit (at 8%) and to switch the same to term repo rate (at 8-9%, based on auctions), which has evolved as a useful indicator of underlying liquidity conditions, will result in a marginal tightening in near-term interest rates.

Simultaneously, RBI policy mentions that contingent upon the desired inflation outcome, real GDP growth is projected to pick up from a little below 5 per cent in 2013-14 to a range of 5 to 6 per cent in 2014-15 albeit with downside risks to the central estimate of 5.5 per cent. Point to emphasis is that the “Lead indicators do not point to any sustained revival in industry and services as yet, and the outlook for the agricultural sector is contingent upon the timely arrival and spread of the monsoon.”

In fact, monetary policy statement should be read in light of recent inaugural speech titled - Fighting Inflation – delivered by Dr. Raghuram Rajan, Governor, Reserve Bank of India at FIMMDA-PDAI Annual Conference 2014, on February 26, 2014 at Mumbai, Governor has in very clear terms and in elaborated manner highlighted reasons for sticky and high inflation and specifically food inflation. Summary para of this speech mentions - In sum then, when we examine food inflation, a substantial portion stems from an increase in food production costs, primarily rural wage inflation. Some of that is an increase in real wages, needed to attract labour to agriculture, away from construction, education, household work, or MGNREGA. If, however, wages elsewhere also go up, the necessary shift in relative wages to keep agricultural work attractive will not take place, and we will continue to have a wage spiral. Also, some of the agricultural wage growth may be because of more liquidity flowing into rural areas.

Last few weeks communication from Central Bank and related officials has been in line with Dr. Urjit Patel’s recommendations and core theme within that has been to implement “inflation targeting framework”. Keeping that in mind, new Government’s economic policies also would need to be crystallised in line with RBI’s monetary policy framework.

Net to net, since Sep’13, the RBI governor has tried to make monetary policy review process very much nimble-footed. And dynamic management has its own advantages and disadvantages. Right now, we need to give benefit of doubt and follow Governor’s no-change stance for policy rates, till it gets reviewed on again in June.

(Views expressed are by Jignesh Shah, independent investment advisor. He is reachable on jshah@capitaladvisors.co.in).