The Reserve Bank of India’s Monetary Policy Committee (MPC) in its maiden sitting reduced policy repo rate by 25 bps.
The cut came as a resolution of the six-member MPC headed by the Governor Dr. Urjit Patel. Interestingly, all six members voted for a rate cut. The twin firsts – the Committee approach and a new Governor at the helm – coupled with handing down of a rate cut right away signal a start that could raise expectations of more to come.
At the surface, this could be on account of a reasonably good monsoon, a Consumer Price Index-Combined (CPI-C) at a low of 3.74 per cent in August 2016, comfortable liquidity conditions, and outlook on growth remaining optimistic.
The MPC has looked at both sides – growth and inflation, citing many adverse effects on both.
But the MPC has been optimistic on food inflation and expects it to moderate. Equally, it has recognised the potential adverse effects on inflation from the 7th Pay Commission award and other factors. And yet, took the view that upside risk to 5% inflation by March 2017 has ebbed out.
In support of the rate reduction, it argued that “the momentum of growth is expected to quicken”. It has retained the growth forecast at 7.6 per cent.
It is interesting and instructive to mention that the technical analysis presented in the second and third bi–monthly review also maintained the same inflation and growth forecasts. The global outlook has remained unchanged over the last two months.
This raises several questions. If the situation is unchanged, why the rate reduction now; does it signal a market friendly approach; what will be the net benefits of the rate cut; how can the MPC ensure that inflation and growth remain at its estimated level; and is this rate cut a one- time measure to keep markets (and the government) happy and then return to vigil mode?
Clearly, the rate cut at this juncture is more sentiment-driven. The market, industry captains, government had a heavy deal of expectations. Therefore, the rate cut could be seen as a tactical move to pacify this strong clamor. The way things stand now, no future rate cut will be possible. Moreover, full transmission of previous rate cuts has not been taken place. Rising NPA levels at banks is a fundamentally serious block to future lending.
Even assuming that the benefit is immediately passed on, it is doubtful whether it could substantially raise credit offtake. The business world needs to be convinced that this is not cosmetic but sustainable. The MPC statement hardly provides any forward guidance in this regard. The resolution should not be interpreted as the dovish stance.
The potential pressure of food inflation persists and crude price rise may also add to this pressure. In this light, one could view this as a strategic rate cut as a new team settles into office and begins taking a hard look at the numbers once again.
(Dr. R K Pattnaik is Professor, SPJIMR. Jagdish Rattanani is Editor, SPJIM. Views expressed are their own and not The New Indian Express’)