By Invitation. Rate cut on hold and rightly so

The backdrop to the monetary policy was an evolving debate on growth erosion and the need for a fiscal push to revive the economy. Even as economists broadly agreed that there was limited chance for a repo rate cut in this policy, certain others were expecting one.

Five members of the Monetary Policy Committee voted to keep the rate unchanged while one member voted for a 25 bps reduction. The stance of the monetary policy remained unchanged at “neutral”.

No doubt, the Reserve Bank of India factored in the growth erosion and agreed that the economy is performing at a sub-optimal level. However, data flow is still not adequate for a clear understanding of the reasons behind the slowdown — how much of it is structural, how much out of the temporary shocks of demonetisation and the GST.

If it is purely the latter, then growth should recover soon and there would be no need for a stimulus of any kind. The RBI, thus, wanted to be doubly sure and wait for incremental data to understand these, to prevent acting in haste and having to reverse the step later.

The RBI has indicated that recapitalising PSU banks, closing the large infrastructure gap, restarting stalled projects, ensuring a faster roll-out of affordable housing programme, etc., could be ways to reinvigorate investment activity.

The problem for the RBI is that it is navigating through a wide range of confusing signals. Even as growth slowed in the first quarter of FY18, there have been some positive signs recently, with the core sector data indicating a pick-up, PMI manufacturing in the expansionary territory and robust auto sales.

The recent cut in the excise on petrol and diesel is expected to release ₹130 billion as disposable income and could provide a boost to consumption. While the RBI revised the near-term growth outlook to 6.7 per cent for FY18 from earlier projection of 7.3 per cent, the growth outlook for FY19 is at 7.4 per cent, not a bad figure by any standards.

On the other hand, from its earlier projection of 4.0-4.5 per cent headline CPI, the RBI has moved the CPI projection higher to 4.2-4.6 per cent for the rest of FY18. Importantly, for FY19, the RBI projects headline CPI to rise further to 4.9 per cent in Q3FY19. This trajectory of inflation into the medium term along with expectation of growth reviving does not provide scope to enact an easier monetary policy.

Critical, at this juncture, is to watch out for strategies the government might undertake to provide some immediate boost to growth. The Centre has already provided some fiscal push with cuts in excise on petroleum products, some States have implemented farm loan waiver and States might do more as they implement revisions of wages and allowances for their own employees in due course.

Studies at the RBI indicate that if the combined fiscal deficit-GDP ratio increases by 100bps, it could lead to a permanent increase in inflation by 50bp, a scenario the RBI will not like.

Given the above, and with the inflation trajectory put out by the RBI, there appears almost zero scope for further monetary accommodation, at least for FY18. Important to note is that a rate cut might not have helped the real economy anyway. Cuts in the repo rate are unlikely to have boosted credit offtake as both banks and corporations continue their struggle to get respective balance sheets in shape.

Further, capacity utilisation is at an unexciting 72-74 per cent across most sectors and demand push has to be really sizeable for the private sector to start investing into capacity. No wonder, the RBI would not like to give up its ammunition when it knows a rate cut now would not help.

However, the attempt continues for better transmission of changes in policy rates to the real economy. The RBI seeks to move from internal benchmark MCLR, to an external benchmark (risk-free curve involving T-bills, CD curve or RBI policy repo rate) for pricing of loans. Further, it envisages interest rate resets on all floating rates once a quarter rather than once a year.

The writer is Group Chief Economist, IDFC Bank Ltd

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