RBI monetary policy 2017: Key takeaway is shift in focus towards 4% inflation target

By: |
New Delhi | Updated: February 9, 2017 4:29:02 AM

In the first monetary policy post the FY18 Union Budget and the second policy post the demonetisation drive, the RBI opted for a status quo in the monetary policy.

This is twice in succession that the central bank decided to hold rates despite consensus expectation of a 25-bps cut in the repo rate. (Reuters)This is twice in succession that the central bank decided to hold rates despite consensus expectation of a 25-bps cut in the repo rate. (Reuters)

In the first monetary policy post the FY18 Union Budget and the second policy post the demonetisation drive, the RBI opted for a status quo in the monetary policy.

This is twice in succession that the central bank decided to hold rates despite consensus expectation of a 25-bps cut in the repo rate. The key change is the policy stance moving from ‘remaining accommodative’ to a ‘neutral’, with the governor mentioning during the media call that the stance gives the RBI flexibility to decrease or increase rates.

The inflation target was unambiguously emphasised at 4% versus previous statements indicating 4% with a band of ±2%. The reasons driving the RBI to remain on pause in Wednesday’s policy differ widely from the December policy. The December pause was more a wait and watch approach amidst the yet unfolding adverse impact of demonetisation. In contrast, Wednesday’s policy was a recalibration of the RBI’s stance towards achieving the 4% inflation target in a calibrated manner.

Indeed, if we view this policy from the previous goal post of 5% inflation by March 2017 and the significant undershooting of actual inflation over the last four months until December, conditions were ripe for a 25-bps rate cut.

Also Watch:

In addition, the near-term weakness in growth post demonetisation and the display of fiscal rectitude in FY18 Union Budget further strengthened the case for monetary easing.

However, the RBI has now shifted gears by looking through the transient impacts of demonetisation and significant undershooting of March 2017 inflation target.

The policy focus is now unambiguously on achieving the 4% inflation goal post in a not-so-favourable backdrop of rising crude oil prices, heightened exchange rate volatility and the statistical increase in inflation due to higher HRA under 7th Pay Commission. While the inflation goal post and policy objective has now been enumerated clearly, few ambiguities still remain:

The RBI has refrained from ascribing any timeline for achieving its 4% inflation target. The sanctity of the previous timeline of March 2018 for achieving the long term inflation target of 4% appears invalid with RBI’s own projections for CPI inflation in the range of 4.5-5.0% for H2 FY18. Prescription of a revised timeline would help in anchoring market expectations, going forward.

The policy statement focuses on the downward stickiness in core inflation. Indeed, core inflation has remained persistent around 4.8% in FY17 so far even as headline inflation has dipped.

However, in my opinion, a true measure of underlying inflation is core-core inflation, which excludes the impact of all fuel and jewellery items from core inflation.

This measure of inflation has been gradually moderating – from 5.4% in December 2015 to 4.6% in December 2016. This rather fits well with the notion of achieving gradual disinflation and is in somewhat in contrast to the stickiness ascribed to by the RBI in its policy document.

Despite these minor inferential ambiguities, the shift in focus towards the 4% target in the medium term comes out as a key takeaway for enhancing policy signal and boosting the relatively recently acquired inflation fighting credibility. With upside risks to inflation in FY18 and given the policy guidance, I believe that the monetary policy easing cycle which had begun in Jan 2015 has now come to an end with a possibility of a prolonged pause.

Get live Stock Prices from BSE and NSE and latest NAV, portfolio of Mutual Funds, calculate your tax by Income Tax Calculator, know market’s Top Gainers, Top Losers & Best Equity Funds. Like us on Facebook and follow us on Twitter.

Switch to Hindi Edition