In some sense it is a Goldilocks policy, just right given the current situation, says Raghuram Rajan, RBI governor.
Stocks and bonds sold off on Tuesday although the Reserve Bank of India (RBI) trimmed the repo rate by 25 basis points to 7.25% with the markets apprehending a prolonged pause in monetary easing and concerned about the unfavourable impact on the economy of a weak monsoon.
The RBI’s higher inflation target of 6% for January 2016, upped from the earlier 5.8%, and the central bank’s commentary to the effect the cut had been ‘frontloaded’ suggest there will be no more rate cuts until uncertainty relating to the monsoon — now expected at 88% of the LPA — and rising crude oil prices is over. Indeed, given the rains could be insufficient and that the service tax has been hiked to 14%, there are clearly upside risks to inflation.
The cut in the repo, RBI governor Raghuram Rajan indicated, was aimed at reviving growth which had been disappointing — corporate results have been poor — and boosting investment which had not picked up. However, future policy decisions, he asserted, remain contingent on data.
Deutsche Bank economist Kaushik Das wrote that he read the statement as shutting the door for further monetary policy accommodation for now. “Not only is the central bank less comfortable about the near-term inflation outlook, it is also increasingly concerned about its stated goal of achieving 4% inflation from 2017 onward,” Das observed.
Sonal Varma, economist at Nomura, believes that although the RBI has left the door open to further easing in the event of further disinflation, “we expect it stay on a prolonged pause — until end-2016 — as we believe that growth is in the initial stages of a business cycle recovery, inflation appears to be stabilising around 5.0-5.5% and inflation expectations are still elevated”.
Rajan described the central bank’s action as a “Goldilocks policy”, neither too conservative nor too aggressive, even as he projected GDP growth in FY16 at a lower 7.6%, with a downward bias. “We have pencilled in higher food inflation but we’re not going to be reckless,” the governor said, highlighting the importance of managing food supplies with adequate buffer stocks, anti-hoarding measures, lowering transportation losses and resorting to imports to rein in food inflation. Economists said the government’s response to a shortfall in the monsoon could be critical since hikes in the minimum support price (MSP) will not merely push up prices of the targeted crops but also distort relative prices.
Rajan said he expected full transmission of the rate cut. Replying to a question on a call with analysts, the governor said he felt substantial transmission would take place, pointing out that the competition may not allow banks to be compensated for sunk costs like credit costs.