RBI monetary policy: Big takeaway is the heralding of the end of demonetisation

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New Delhi | Published: February 9, 2017 5:02:36 AM

RBI Governor Urjit Patel said at the post-policy press conference, if the sharp fall in food prices were to be stripped out, headline inflation for December would be higher than the official number by as much as 140 bps.

Reserve Bank of India.(Reuters)Reserve Bank of India.(Reuters)

Given the hardening commodity prices globally, a weakening rupee and the likelihood of the Fed hiking rates in the US, the chances of the central bank cutting repo rates by 25 bps were always 50:50 given the somewhat sticky core inflation of around 4.9% in the October-December period—as RBI Governor Urjit Patel said at the post-policy press conference, if the sharp fall in food prices were to be stripped out, headline inflation for December would be higher than the official number by as much as 140 bps. What is noteworthy about the credit policy, however, is that with RBI talking of the need to ‘assess how the transitory effects of demonetisation on inflation and the output gap play out’, this is the first official recognition of the possibility of supply-side disruptions—if there are supply disruptions, the output gap will narrow and inflationary pressures will rise. That would also have been a reason for the central bank’s decision to pause.

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More worrying, and that is why bond yields rose sharply after the policy statement, is RBI’s change in policy stance from accommodative to neutral. While that gives the central bank the flexibility to move in either direction as macro conditions change, the shift suggest it is looking to achieve a 4% inflation target more quicker than was anticipated earlier—in which case, further cuts in the rate cycle look unlikely unless there is an unexpected collapse in core inflation. At a time when there are big supply constraints in the economy, and not all inflation can be controlled through monetary policy, this suggests interest rates will remain high—the impact on growth is likely to be negative.

Since the government is looking at a liquidity-driven lower-interest-rate regime stimulating demand, the focus now has to shift to getting the banking system to match the 175 bps rate cut by the central bank since January 2015. While banks are talking of the sharp cuts made by them in the MCLR, the fact is the proportion of borrowers affected by this is not large. According to Crisil, while the MCLR has been cut 106 bps, the fall in base rates is a much lower 72 bps—keep in mind deposit rates have also fallen 188 bps over the same period. But for banks to be able to make meaningful cuts in base rates, as the policy points out, the government has to do its share—and it has done little there. Like the Economic Survey, RBI’s policy statement talks of the need to resolve the issue of rising NPAs quickly, the need to recapitalise banks fast—the allocation for this has fallen to R10,000 crore for FY18 as compared to R25,000 crore in FY17—and to adjust interest rates on small savings in keeping with the fall in rates on G-Secs of corresponding maturity; despite announcing this last year, the progress on this has been patchy. The ball is back in finance minister Arun Jaitley’s court.

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