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Credit Policy: No Second Guessing Here

The Central Banker’s tough stance on inflation lays to rest the questions on its autonomy, writes Clifford Alvares

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If the RBI’s recent credit policy is anything to go by, talk of whether the central bank is really an independent institution is proving just that, mere talk, considering that the RBI walked the path on its mandate of inflation-targeting keeping aside economic-growth considerations for the moment.

Against the wide expectations of bankers, economists and industry stalwarts, the Monetary Policy Committee (MPC), headed by RBI Governor Urjit Patel, did not let its guard down against inflation. The RBI in its announcement on 8 February kept the repo rate or the lending rate status quo at 6.25 per cent.

After the demand-squeezing effect of demonetisation, a rate cut was seen as a kick-starter to the economy. A 25 basis point rate cut would have spurred more dips in rates, which could have brought back demand for automobiles and housing.

Well, RBI is doing no such thing and, to top it, the central bank has altered its policy commentary from ‘accommodative’ to ‘neutral’, which came as a shocker to the financial markets. The impact on bond markets was knee-jerk. The 10-year government securities (G-sec), which dipped to 6.4 per cent post-demonetisation, climbed to 6.7 per cent, back to its pre-demonetisation levels (See chart: Back To Square One).

The RBI has had an ‘accommodative’ stance on interest rates for some time now implying a general downward bias in interest rates. The rates have been on a downward trajectory for the past two years, since January 2015, with cumulative cuts of 175 basis points till date.

“Markets were expecting a rate cut, but the full impact of the demonestation is still unclear,” say Kuntul Sur, Partner, Risk and Regulatory, PwC India. “This is an apolitical move and I don’t see any influence whatsoever.”

With this changed stance, the credit policy has squelched all questions that have arisen in recent times concerning the RBI’s autonomy, post-demonetisation.

On the contrary, in the last few months especially, with the setting up of the Monetary Policy Committee (MPC) and the inflation-targeting framework, the primary responsibility of the RBI has been to train its guns on inflation. For now, the RBI is targeting an inflation of 4 per cent. Post-demonetisation, the RBI pointed out that, while core inflation has been stable, the fall in inflation has been largely because of the fall in vegetable prices, which led to the dip in food inflation. But as growth picked up in coming months, it was expected that inflation would possibly rear its head again, which prompted the RBI to take a precautionary stance.

External Forces

A continuous drop in prices of vegetables and other perishables can be ruled out. The supply side of vegetables and other perishables has been better due to factors like a good monsoon and even demonetisation. But as food demand is rising, and crop yields are not getting better, there is no reason to believe that a continuous drop in prices of food and foodstuff is on the cards.

Hence, a steady disinflation scenario is playing out in the economy and prices are now seemingly bottomed out. Indranil Pan, Chief Economist, IDFC Bank, says, “Inflation figures could perhaps dip once more before rising. The RBI has clearly taken a forward-looking stance.”

Another factor that leads to inflation swinging wildly is oil prices, currently at $52 a barrel in the global markets. Crude has strengthened lately, and hence the cautionary stance. In its policy statement, the RBI was unequivocal about the stickiness of inflation. “Excluding food and fuel, inflation has been unyielding at 4.9 per cent since September. ...While some part of this inertial behaviour is attributable to the turnaround in international crude prices since October, a broad-based stickiness is discernible in inflation, particularly in housing, health, education, personal care and effects (excluding gold and silver) as well as miscellaneous goods and services consumed by households,” the RBI said in its policy statement.

The central bank also said that it is committed to bringing headline inflation closer to 4 per cent “on an enduring basis and in a calibrated manner”.

Easier To Change Gears Now
Due to this inflation-targeting framework, the RBI took the ‘neutral’ stance. But it is a stance that is still flexible. Market experts point out that the neutral stance allows the RBI the room to manoeuvre either way up or down depending on the direction in which inflation moves.

IDFC Bank’s Pan says, “A neutral stance is where you don’t change your rating, but you actually move from a positive bias to a neutral bias and, therefore, in future from neutral you can shift into the front gear or into a rear gear. Either is possible. Till you understand your inflation trajectory, it is very difficult, therefore, from a neutral stance to determine which way you would pull your throttle.”

Hence, removing all expectations from the market on rate direction is a better strategy than having the market second-guess the rate cut. Lately, the bond market had raced ahead, and bond yields had dipped. But from the perspective of the international market, lower yield differences between the US and India does not attract foreign inflows into the country.

In the US, 10-year yields are hovering at 2.5 per cent, while India’s falling yields reduces the gap down to just about 4 per cent. Hence a cooling down of the expectations and signalling a pause immediately, than letting the market front-run the central banker, is par for the course. Linked to the currency inflows is also the fact that the rupee could see some weakness, accentuating inflation pressures.

For monetary policy makers, this walk is not easy. On one hand, the policy has to reign in the over-expectations of the market place; on the other, there is need to boost demand and increase economic growth.

Hoping For The Best
Despite the Reserve Bank’s stance on the rate cut, the good thing is that experts are still not ruling out another final 25 basis point rate cut if inflation is tractable. Says Aditi Nayar, Senior Economist, ICRA: “We are not ruling out one more 25 basis point rate cut. In any event, we were of the view that the scope for further easing was limited to one additional rate cut.” If that comes about, we would probably see a higher growth trajectory.

Sur points out that the RBI does not necessarily have to signal a rate cut in the next policy, and it could even do so much earlier, especially if the incoming data is accommodating. “Things are so fluid that we have moved from a half-yearly policy to a bi-monthly policy. It is not necessary that the RBI should announce a rate cut only on policy days.”

But, there is no doubt that the RBI is firmly marching on its inflation-fighting ways and the questions regarding its autonomy are answered.