Another surprise

RBI seems concerned about fiscal discipline

The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) seems to be making a habit of throwing up surprises. In the past two bi-monthly reviews, the MPC chose to raise policy rates while keeping its stand “neutral”. Since the last policy review, the Indian basket of crude oil prices has gone up by around $13 a barrel. Given the steady depreciation of the rupee, it was widely expected that the MPC might be left with little option but to raise rates — the suspense was only over the extent of the hike. This was even more true because the United States Federal Reserve continued increasing its rates. But the MPC chose to surprise everyone yet again by announcing the status quo on the policy rates while changing the stance from “neutral” to “calibrated tightening”. That means that in future the MPC will either stay put or raise the rates. In his media interaction, Governor Urjit Patel clarified that “today’s (Friday’s) stance of calibrated tightening essentially means that in this cycle, rate cut is off the table and that we are not bound to increase rates at every meeting because that is not required given our inflation outlook and forecasts at this point in time”.

The retail inflation rate, as measured by the year-on-year change in the consumer price index, has fallen sharply from 4.9 per cent in June to 3.7 per cent in August. Given that the RBI is now mandated by law to keep the retail inflation rate at 4 per cent level, with a leeway of 2 percentage points either side, it made sense for the RBI to pause before hiking again. Moreover, as the MPC has given a lot of importance to the RBI’s household survey of inflation expectations in the recent past, this variable too shows some abating. So while the September round of the RBI survey of households reported a sharp uptick of 50 basis points in the three-month ahead inflation expectations over the last round, the one-year ahead expectations have reportedly moderated by 30 basis points. Not surprisingly then, the RBI has rolled back its inflation projection to 3.9-4.5 per cent for the second half of FY19, down from 4.8 per cent earlier. For the first quarter of FY20, inflation is now projected at 4.8 per cent.

Mr Patel and his team in the RBI also appeared less bothered about the rupee’s slide against the dollar and declared that there was no specific target or range that the RBI intended to adhere to in this regard. Instead, they would be focused on only managing “undue volatility”. The flip side of this benign outlook on inflation and the rupee’s depreciation could be a possible worry about economic growth and macroeconomic stability, particularly a slippage on the fiscal front. “With global headwinds posing major risks to the growth and inflation outlook, the MPC believes that the highest priority is further strengthening of domestic macroeconomic fundamentals,” said Mr Patel. To that extent, after inflation, it is the fiscal slippage that the RBI is concerned about as it can crowd out private borrowing and raise questions about India’s economic recovery.