MUMBAI: Hold and behold! That’s been the mantra of the Reserve Bank of India (RBI), not with regards to rates, but its stance on monetary policy, which was set neutral since February 2017.
It’s probably the longest in recent times that the RBI stayed ‘neutral,’ allowing itself flexibility to hike or cut rates at will. The downside is, it shows uncertainty in monetary policy forecast and could even delay investment decision-making.
The six-member Monetary Policy Committee has only one job: gauge economic variables and forecast its policy direction for the rest of the world, by being dovish (implying rate cuts) or hawkish (consecutive hikes). It can stay neutral, but doing so for extended periods only creates uncertainty.
From a political standpoint, the August policy is perfect for a rate hike, as anytime later would be a blow for the NDA government, which is likely to call for early polls. Hiking later, amid a downward inflation trajectory, could also be challenging, coming just ahead of the festive season and busy credit season. Valid augments exist for both a hike and status quo considering inflation, economy and external factors.
Hike-side economists favour a 25 bps increase as headline inflation is above 4 per cent, core inflation remains sticky (with added MSP-hike risks), weakening Rupee, and output gap that’s closing in and could spook inflation.
The other side believes there’s no need to rush for another hike. Though core inflation peaked, it will ease later if not sooner; economic activity improved, but more due to normalisation of demo and GST-led disruptions than due to recovery. Lastly, Rupee is overvalued, and so, a wait-and-watch approach is needed.
The RBI’s job is to supply just the right amount of money so that prices remain stable. Core inflation rose in the past six months, but it’s not demand-driven, and partly due to low base and rising input prices. The central bank moves policy rates only when inflation is due to excessive monetary growth, and when it’s transitory.
Food inflation is typically high by up to 2 per cent during June and July. For instance, as per an RBI study (out of a sample 184 months), monthly inflation rate was highly volatile, at times as high as 20-30 per cent on annualised basis. But after seasonal adjustments, annual inflation rate was often smoother than the monthly series.
Also, real rates (repo rate adjusted for projected inflation) are close to 160 bps, not far below the MPC’s preferred level of 175 bps. In short, the current macroeconomic conditions do not warrant a rate hike, but clarity on the future course, particularly if the MPC favours a tightening bias or not is highly warranted.