RBI's New Monetary Policy Statement Is Surprising – In a Good Way

The RBI's statement, the first after the Budget, carries forward the Budget's message of fiscal discipline and consolidation.

The Monetary Policy Committee in its statement of February 8 sprang two surprises. The relatively minor one was to hold policy rates. The policy repo rate remains unchanged at 6.25%. Consequently, the reverse repo rate remains unchanged at 5.75% and the marginal standing facility rate and the bank rate both at 6.75%.

This is the second time in a row that the RBI has held rates. There were optimists who expected a rate cut but as was the case before, at least among close market watchers, the policy-eve expectation of a rate cut was tempered by the realisation that the RBI might have touched the bottom of its interest rate cycle. According to this view, further cuts are not on the cards at least till the end of this year.

It is for these reasons that the maintenance of a status quo in the rates ought be considered only as a minor surprise. By far a bigger surprise has been the shifting of the monetary policy stance from ‘accommodative’ to ‘neutral’.

Behind this changed stance are at least three important reasons: the view that growth will rebound during the second half of the year, the RBI’s desire to focus on inflation and move decisively to the 4% target (headline CPI) and there are concerns that inflation will rise beyond the 4% target in the medium term and very likely be in the range of 4.5-5%.

The further argument is that if the central bank found it difficult to cut rates when its stance was accommodative (as was the case till recently), it will be far more difficult to do so when it had tightened its stance.

A change might happen only if inflation and growth overshoot their targets. The point has been made that even a neutral stance admits of flexibility. The RBI will intervene if circumstances so warrant.

The threat to upside risks on inflation materialising  are real. At least three factors matter here: the hardening of global fuel prices which analysts do not expect to soften, volatile exchange rate movements partly caused by an unpredictable Donald Trump administration and delayed implementation of the Seventh Pay Commission.

Core inflation excluding food and fuel has been sticky at 4.9% since September.

Demonetisation and monetary policy

In December, there was an overhang of liquidity consequent upon demonetisation. But according to the policy statement from mid-January, some rebalancing has been under way with expansion of currency in circulation. Demonetisation has caused a flood of deposits with banks. This will bring down the commercial lending rates. This is not an unalloyed blessing however, as on the deposits side banks have to bear an as yet indeterminate cost in booking the deposits. Second, a surfeit of funds will not by itself contribute to a healthy lending portfolio. The point has been made several times before that credit availability is not the same as credit delivery.

There is no doubt that some banks eager to lend might end up with non-performing assets. After all, banks are judged by profitability parameters. Idle cash balance does not contribute to healthy balance sheets.

Households have no cause to cheer. In yet another glaring omission, the monetary policy has failed to highlight the travails of households in the face of rapidly falling bank deposit rates. Needless to add, bank deposits are the only safe investment option to households, especially for the vulnerable sections such as pensioners.

Far from paying even lip service to their cause, the policy statement hints at the need for adjusting small savings interest rates to changes in the yields on government securities. This, it says, is to enable better transmission of policy rates to the economy.

The policy statement plays safe with its expectations of growth. GVA growth for 2016-17 is projected at 6.9% with risks “evenly balanced”.

For 2017-18, the RBI is much more optimistic. Economic growth is expected to revive sharply. Among the factors it is banking on, the discretionary consumer demand held back by demonetisation is expected to bounce back during the last quarter of the current year.

A verdict on the sixth bi-monthly statement should reckon with macroeconomic management in its entirety. The Budget, whatever be its shortcoming, emphasised fiscal discipline. The RBI statement, the first after the Budget, carries forward the message of consolidation. The absence of a rate cut along with the changed policy emphasis are very relevant pointers.

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