RBI maintains it retains a bias to ease rates further

Published: December 2, 2015 12:07 AM

Overall, the central bank seems relatively relaxed about the inflation outlook, at least in the short term

The Reserve Bank of India (RBI) duly left its key policy rates unchanged after springing a 50 basis points (bps) surprise at its last policy review. There was little evolution in the RBI’s FY16 GDP growth and inflation forecasts. The policy statement made clear that the apex bank retains a bias to ease further, noting that ‘space’ for further accommodation will be used when it is ‘available’.

Inevitably, commodity prices, fiscal policy and the continued extent of policy transmission are all cited as the key pressure points. Any change in policy before next year’s Union Budget (due end-February) is unlikely. Worryingly, the tendency to blow hot and cold on various indicators continues (the 1-year T-Bill for example), unhelpfully obfuscating the central bank’s true reaction function.

The RBI sprang no surprises at its final policy review of the year. Having already cut its key policy rate by 125 bps so far this year and by a larger-than-expected 50 bps at its last policy review, the bank was content to leave policy unchanged as expected.

As usual, the increasingly lengthy accompanying statement provided abundant and as usual insightful analysis of conjunctural developments, but was relatively coy on the outlook for monetary policy. It made clear that the central bank retains a bias to ease policy but that it will only provide further accommodation when such ‘space’ becomes ‘available’.

The laundry list provided by the apex bank on what will influence policy was a familiar one. Essentially it boils down to the inflation outlook and the policy mix i.e. the interplay with fiscal policy. External developments, particularly the expected fallout from the expected lift off by the US Federal Reserve, are also important.

On inflation, some concern about the potential for food prices to pick up given this year’s deficient monsoon was expressed and the very slight uptick in core CPI prices, basically services, was also flagged. But overall, RBI seemed relatively relaxed about the inflation outlook at least in the short term.

The lack of transmission from earlier cuts was again cited. More concern was adumbrated over fiscal policy particularly following the announcement of the 7th Pay Commission which can be thought of as an upside risk to demand crystallising.

As before, the statement emphasised that it is critical that the government acts to offset the Pay Commission’s impact on domestic demand and it remains on its planned fiscal consolidation path. Overall, the impression that the policy mix is increasingly the dominant factor in RBI’s reaction function is further cemented. Accordingly, any shift in policy before next February’s Union Budget looks unlikely.

This also helps explain RBI’s increasing willingness to flip flop in terms of indicators used to justify or explain policy decisions. Inflation expectations for example have been emphasised, ignored then reemphasised.

The last policy statement and press conference stressed the one-year T-Bill rate as a policy lodestar only for this to disappear in today’s policy statement. Greater uncertainty over RBI’s ‘true’ reaction function is inevitably the

The decision not to roll out new fan charts for the bank’s FY17 GDP growth and inflation projections, but to continue showing what are now just three-month ahead developments for the remainder of FY2016 is also clearly sub-optimal. While a desire to avoid predictability is understandable, even healthy, reduced transparency is unhelpful for all parties.

By Richard Iley

(The author is chief economist for Asia at BNP Paribas)

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