RBI Policy: A Realistic Assessment of Growth and Inflation

The MPC claims that the decision to narrow the policy corridor is consistent with a neutral stance of of monetary policy.

Office of the Reserve Bank of India. Credit: PTI

Office of the Reserve Bank of India. Credit: PTI

The Reserve Bank of India’s first monetary policy statement of the year was widely expected to stay clear of interest rate changes. Liquidity absorption, rather than a policy rate reduction, was on the cards.

In the post-demonetisation era there has been a surge in bank liquidity. Deposits have increased by Rs 4.27 lakh crore. During the last financial year, deposits grew 13% year on year till  March 17 while credit grew at a measly pace of 4.4%.

Many other factors contributed to a surge in liquidity: Large investments by foreign institutional investors in the Indian stock markets was one such factor. The RBI’s attempts at preventing rupee appreciation would involve buying of dollars and the consequent release of rupees.

With liquidity absorption being a key objective, the Monetary Policy Committee, while not raising the CRR, as it was expected to do in some quarters, however did raise the reverse repo rate to 6%.

The important development therefore is that the narrowing of the liquidity adjustment facility (LAF) since the policy repo rate has been left unchanged at 6.25%. The policy document claims that the decision to narrow is consistent with a neutral stance of of monetary policy. The medium term target for CPI inflation is 4% within a band of of plus or minus 2% while supporting growth.

Thus with the two cardinal objectives of monetary policy — keeping a check on inflation without hampering growth — remaining the same, the policy document takes note of developments within India and abroad.The most noteworthy development abroad has been the stronger growth seen in most advanced economies (AE). In emerging market economies (EMEs), especially the large commodity exporters, recessionary conditions are easing. It is safe to say that in most of them the slowdown characteristic of 2016 is bottoming out.

The outlook for domestic economy has generally been buoyant. GVA growth for 2016-17 is estimated to be 6.7% according to the Central Statistics Office”s second advance estimate.The MPC is modestly optimistic over near term growth prospects overall with a forecast of 7.4%. This is despite the fact that progress has been uneven across sectors recently. Focussing on inflation,the MPC points out that since February inflation has been quiescent. For 2017-18, inflation is projected to average 4.5% in the first half climbing up to 5% during the second half. Remonetisation is gathering steam and is expected to play an important part in macro growth. Altogether, both growth and inflation risks are evenly balanced.

Among the important announcements that have a bearing on monetary policy, the central bank has allowed banks to invest in Real Estate Investment Trusts (REITs). A new policy framework will be announced to strengthen the weakest banks.These two proposals are no doubt welcome but they have been in the making for a very long time.The last word on demonetisation has obviously not been said. The next round of review in June will clarify a number of issues.