Entirely in line with expectations, the Reserve Bank of India in its fourth bi-monthly monetary policy review did not change the policy repo rate, which remains at 8 per cent.
The main determinant of monetary policy has been to get a handle on inflation. This has been very well articulated by the RBI Governor both through the policy statements and outside. In fact, this time the Governor had amply made it clear that a rate cut was out of the question given the inflation scenario. The RBI has not only explained why a rate cut was not possible this time but has also more than hinted as to why there might not be any change for quite sometime. The ‘pause’ may well extend to the greater part of 2015. The reason, of course, is inflation. While the RBI is fairly confident of reaching its target of 8 per cent retail inflation by January, 2015, it is far less certain about its medium-term target of 6 per cent by January, 2016. The central bank’s views on the glide-path for inflation are the same. However, the risks to attaining the 6-per cent target by January, 2016, remain even though they have lessened compared to August. As to why achieving a 6 per cent inflation target by January, 2016, may be so difficult, the RBI Governor explained that lots of things can happen in the world.
The present softening of commodities prices, especially of oil — now trading below $100 a barrel — might not last indefinitely. Food prices may spike. The impact of the recent monsoons has not been assessed fully.
Incidentally, it is on the basis of the >Urjit Patel committee’s recommendations (January, 2014) that the targets for inflation based on the CPI rather than the WPI were first formalised. The bi-monthly policy review format is also based on the same committee. However, till now, the government and the RBI have not formally accepted the committee’s recommendations.
The major implication of the fourth bi-monthly policy review is that the RBI framework puts a higher weight on promoting macroeconomic stability and pursuing real interest rates. On the latter, the financial savings of households could certainly do with inflation —beating real returns. After a long time, bank depositors are poised to get a real return (nominal interest rates adjusted for inflation). In that context, the moves to reduce the deposit rates by leading banks will nullify the impact of falling inflation.
Another clear inference is that the RBI expects the government to tackle the supply side issues relating to food. Food inflation accounts for a significant part of retail and wholesale inflation indices. In the CPI index, food inflation at 9.5 per cent is still high although in the WPI, it has shown improvement. The RBI has to wage a relentless war in keeping down inflation expectations.
Recent policy statements and clarifications by the Governor and senior officials are meant to downplay the overweening focus on rate actions in the policy review. The policy announcements ought to be viewed for the structural changes they propose. This time, there is a further calibrated move to cut the held-to-maturity (HTM) ceiling by banks. This will pave the way for a more orderly development of institutions. By tweaking the norms for calculating the liquidity coverage ratio (LCR), banks are allowed greater access to funds for their normal deployment. The announcement to create a central repository for frauds is another welcome step. The decline in credit disbursements by banks — it has dropped to below 10 per cent on year-on-year basis — is a worrisome development. The RBI, however, thinks it is not due to high interest rates. The base effect may be at play. Besides, companies may be mobilising money from outside the banking system. Oil companies have not been fully utilising the limits allotted to them.
The RBI has emphatically stated that future policy changes will be entirely dependent on data. Its projections on medium-term inflation — 6 per cent by January, 2016 — will be the pivot around which other policy changes will devolve.
In sum, the latest monetary policy review carries forward the main tenets of recent statements, namely, inflation, especially retail inflation, remains a worry ruling out a rate cut for quite sometime. It is more difficult to achieve the 8 per cent near-term target by January, 2015 than the 6 per cent medium-term target by January, 2016. All these lead to the conclusion that monetary policy reviews need not be — and as recent ones show — focussed only on rate changes.
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