RBI’s decision to hold interest rates reveals rift with Centre

Prices outlook:RBI lowered its inflation projection to the 2-3.5% range for the first half.AFP

Prices outlook:RBI lowered its inflation projection to the 2-3.5% range for the first half.AFP  

The decision by the Reserve Bank of India (RBI) to keep the policy repo rate unchanged, shrugging off a sharp deceleration in retail inflation, brought to the fore clear signs that the Centre and RBI are not seeing eye-to-eye on interest rates.

Addressing a customary post-monetary policy press conference on Wednesday, RBI Governor Urjit Patel told the media that the members of the Monetary Policy Committee (MPC) had declined an invitation to meet with Finance Ministry officials ahead of the policy review.

“The meeting did not take place,” Mr. Patel said, when asked whether such meetings could undermine the central bank’s autonomy and hurt the credibility of the MPC. “All the MPC members declined the request of the finance ministry for that meeting,” he said.

The six-member MPC’s decision to hold rates and retain a “neutral” stance was also the panel’s first to lack unanimity, with one member, Ravindra H. Dholakia, dissenting. However, the RBI did not specify whether Mr. Dholakia was in favour of cutting or raising interest rates.

Views on inflation

Tension had been brewing between the central bank and the Centre for some time over several issues, but the most important disagreement was over the RBI’s views on inflation. The RBI had, in February, changed its policy stance from ‘accommodative’ to ‘neutral’ due to inflation concerns, surprising many.

While Consumer Price Index (CPI) data released last month showed retail inflation slowed to 2.99% in April, the MPC opined that the question as to whether the unusually low momentum in the reading for April would endure was something that needed to be still assessed. However, after citing a couple of caveats relating to food and fuel prices, and core inflation, the RBI projected headline inflation to be in the 2.0-3.5% range for the first half of the current fiscal year and 3.5-4.5% in the second half.

The MPC highlighted the risk of ‘premature action’ at this stage and said it would be wise to remain watchful of incoming data, thus avoiding disruptive policy reversals at a later stage. The RBI also pared its projection for GVA growth for FY18 by 10 basis points to 7.3%.

Centre counters

The Centre, however, differed sharply with the RBI on inflation. “In recent times, seldom have economic conditions and the outlook warranted substantial monetary policy easing,” Chief Economic Adviser Arvind Subramanian told reporters, slamming the RBI’s position on inflation. He termed real policy rates as “tight and rising” at a time of low inflation and slowing growth.

“I think there is a plausible alternative macro-economic arrangement,” Mr. Subramanian said. “In this view, not just the headline inflation has been running well below the target and so far in advance, but core (which does not include transitory elements) inflation has also declined sharply,” he said. The inflation outlook had also been rendered benign by an appreciating exchange rate and a good monsoon.

Not all economists see a rate cut in the near future.

“Rate cut not a done deal!,” wrote HDFC Bank chief economist Abheek Barua in a note to clients. “It could also be the case that the RBI is reluctant to change its stance too-fast too-soon. Therefore, if the monthly inflation momentum moves closer to the lower end of the RBI’s projected path, then a rate cut cannot be ruled out.”

Mr. Patel, who has been critical of farm loan waivers announced by some States, cited the risk of fiscal slippages that could entail inflationary spillovers. The RBI also took steps to boost credit demand. The risk weight and standard asset provision requirement for home loans were pared.

Banks’ statutory liquidity ratio requirement was also cut by 50 bps to 20%, freeing resources.

(With inputs from Vikas Dhoot in New Delhi)

Recommended for you