RBI credit policy review: Urjit Patel and MPC's second monetary policy review also happens to be the first after Modi government's decision on demonetisation.
RBI credit policy review: Urjit Patel and MPC’s (Monetary Policy Committee) second monetary policy review also happens to be the first after Modi government’s decision on demonetisation. The Narendra Modi government on November 8 announced that all old Rs 500 and Rs 1000 notes will cease to legal tender money. The move was aimed at rendering black money useless. However, with a huge amount of money being withdrawn from circulation, there is a near-unanimous view that the short-term impact on growth would be harmful.
All eyes are now on RBI governor and MPC to check the possible contractionary impact of demonetisation and provide growth stimulus to the slowing Indian economy. Analysts widely expect the MPC to cut the key repo rate by 25 basis points. But what are the factors that are weighing on Urjit Patel and the MPC’s mind?Why just 25 bps, why not cut rates by 50 bps?
1. Demonetisation: How will RBI counter the short-term evils of this reform? Many global analysts and agencies have cut India’s GDP growth forecast for the current fiscal on account of the demonetisation drive. Fitch Ratings has lowered India’s GDP growth forecast to 6.9% from 7.4%, stating that it expects “temporary disruptions” to economic activity post demonetisation. Given that RBI’s mandate is to also ensure economic growth, Patel and MPC would surely weigh impact of demonetisation, both short-term and long-term, before deciding on rate cuts.
2. GDP growth: Ecen without demonetisation, the Indian economy’s growth trend is subdued. Domestic private investment is low and exports are not witnessing a good period either. Given that global demand is not favourable and domestic factors are also weighing, RBI would do well to provide a growth stimulus. The rate cut would propel investment at the right time, feel analysts. In its last monetary policy review, the MPC had indicated a more favourable shift in focus towards growth, implying that RBI may well go in for a rate cut.
3. Inflation: Keeping inflation in the 4% range (+/- 2%) is the MPC’s mandate and there is little doubt that before every credit policy review this is one of the biggest factors that RBI and the committee would consider. Inflation entered a benign phase with a good monsoon keeping food inflation in check. Analysts and economists are of the view that inflation will come down further with a huge amount of liquidity being absorbed from the system because of demonetisation. CPI inflation for the month of October came in at a comfortable 4.2%, a fact that would further encourage the MPC to cut repo rate.
But if all domestic conditions warrant a rate cut, then why do analysts expect only a 25 bps reduction. Why not 50 bps? That is because, for the MPC, global factors such as an imminent US Federal Reserve rate hike and its impact on global bond yields, Eurozone and commodity prices following the OPEC decision to cut production will restrict the central bank.