The fifth bi-monthly monetary policy statement for 2017-18, setting out the resolution of the Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC), has kept the policy repo rate unchanged at 6.0 per cent on concerns of rising inflation. This decision is in line with market expectations. Five members voted for a status quo and one member, Ravindra H. Dholakia, voted for a reduction of 25 basis points, something he had also prescribed in the October 2017 resolution. The reverse repo rate and marginal standing facility remained unchanged at 5.75 per cent and 6.25 per cent, respectively. Emerging risks of inflation in terms of food, fuel and housing coupled with enhanced household inflation expectations were the main driving factors for keeping the policy rate on hold.
The inflation outlook in Q3 and Q4 of the current financial year was revised upward by MPC within the range of 4.3- 4.7 per cent, as against 4.2- 4.6 per cent in the October resolution. The contributory factors for this upward movement in headline Consumer Price Index inflation as the MPC outlined are (a) reversal of the moderation of core inflation (headline inflation minus fuel and food inflation), (b) higher trajectory of housing inflation emanating from house rent allowances given by the central and state government under the seventh pay commission, (c ) sustained firming up of international crude prices due to the decision of OPEC to maintain cut backs in production and (d) firming up of inflation expectations by households with potential and probable increase food and fuel prices. In addition, there could be an impact of fiscal slippage on inflation due to farm loan waivers by some states, GST rate reduction and the roll back of excise duty and VAT.
Apart from these domestic factors, global factors in terms of pace of and uncertainty over monetary policy normalisation in advance economies and fiscal expansion in the US have the potential source of higher inflation. The decision to keep the policy rate on hold is in line with the central objective of monetary policy of the Reserve Bank “to maintain price stability keeping in mind growth”. In other words, the MPC is committed to keep the CPI inflation under the inflation targeting framework at four per cent within the band of +/- 2 per cent while supporting growth. The MPC has kept the outlook on the growth rate (Gross Value Added, GVA) unchanged at 6.7 per cent for 2017-18 primarily because the RBI survey has indicated improvements in “demand, financial conditions and the overall business situations in Q4”. Q3 growth was projected up to 7 per cent growth and Q4 to 7.8 per cent growth. Nevertheless, there could be a negative impact on growth from higher international crude prices coupled with shortfalls in kharif production and rabi sowing, causing down side risks to agriculture.
Having made a case for no change in growth outlook as mentioned above, the MPC further observed that the following developments would help growth trajectory. These include: (a) Substantially higher capital raised in the primary market which would not only help to set up new project but also contribute to enhance growth prospect in the medium term, (b) Improvement in the rank of doing business (from 130 to 100 ) would help attracting Foreign Direct Investment (FDI), (c) There will be some comfort zones for credit flows to productive sector from the Insolvency and Bankruptcy Code (IBC) and recapitalisation of the PSU banks. The MPC has decided to maintain a neutral monetary policy stance. However, the RBI managed to absorb surplus liquidity from the market through regular variable rate repo auctions and Open market operation (OMO) sales. The total absorption of durable liquidity during the financial year so far was Rs. 1.9 trillion. As a result, the weighted average call rate (WACR) hovered around the range of 12- 15 basis points lower than the policy repo rate vindicating the success of liquidity management by the RBI .
Nevertheless, the issue of improved transmission of the past policy repo rate to bank lending rate has remained unsettled and unresolved. It is important that the RBI should take a quick, firm and sustainable decision on the benchmark rate and advise the banks to link the bank lending rate to this rate. There are views that the MPC is overstating the CPI inflation rate and thereby maintaining the real policy repo rate (policy repo rate minus CPI inflation rate) at a higher level and the real rate of 1 per cent could be appropriate. This decision is helping foreign investors invest in the Indian capital market and domestic investors are penalised with a higher borrowing domestic rate. This issue needs to be assessed by the MPC sooner or later. One way to do this is MPC may consider a rule based monetary policy outlining the neutral real policy rate keeping a consensus view on output gap and also a consensus view on the projected CPI inflation rate under the inflation targeting framework. A medium term monetary policy rule will thus be helpful.