Feb 08, 2018 10:44 AM IST | Source:

RBI Policy review: Market’s non-reaction is the perfect reaction

The RBI did flag off the risks to inflation, but did not sound alarmist.

Joydeep Sen

The RBI Monetary Policy Committee (MPC) presented the sixth bi-monthly Review today, where they held their horses on policy rate action. Market reaction was muted; bond yields came down marginally (i.e. prices went up) and equity indices came down a bit. Given the volatility of the recent past, when equity indices have been moving by hundreds of points on a day and bond yields swaying by 10 to 20 basis points, this may be called a non-reaction. This is how it should be.

A policy ‘review’ is a review and need not necessarily translate to rate action. It is more of a guidance and gives a clue on the thought process of the committee. For the markets, a palpable reaction is understandable when there is a departure from expectations, like in February of last year when the stance on policy rates changed from ‘accommodative’ i.e. inclined towards rate cuts, to ‘neutral’ i.e. would change rates only if there is something significant. Let us now look at some of the details of today’s review and the forward guidance.

Guidance from the review

Inflation projections have ticked up, understandably. The earlier projection, made in the review on Dec 6, 2017, was CPI inflation of 4.3% to 4.7% in second half of this year i.e. October 2017 to March 2018. As against that, inflation in the third quarter i.e. October to December 2017 has been on the higher side, at 4.6%. Inflation expectation in Q4 i.e. January to March 2018 is 5.1%, higher than thought earlier. Inflation is apprehended to move up further to 5.1% to 5.6% in first half of next year, April to September 2018. It is then expected to ease to 4.5% to 4.6% in the second half i.e. October 2018 to March 2019, helped by a favourable ‘base effect’ i.e. higher inflation in the corresponding period previous year.

On growth, the GVA i.e. gross value added, a different way of looking at GDP, it is expected to be marginally lower at 6.6% this year, FY18, against 6.7% projected earlier. Next year, FY19, GVA growth is expected to be at 7.2%. The GVA growth projection of 6.6% is higher than the estimate of 6.1% of government’s Central Statistical Organization (CSO), but the CSO estimate is largely believed to be conservative, on the lower side.

Voting pattern of MPC

Out of six members of MPC, 5 voted for status quo on policy rates. One member, Dr Michael Patra, voted for 25 bps increase in policy rates. In a situation where the market is apprehending rate hikes going forward, the voting pattern of 5-1 should give some solace.

Perspective and takeaways

It is well known, even before the policy review, that there are upside risks to inflation, emanating from the proposed hike in minimum support price (MSP) for crop procurement, high crude oil prices, slippage in fiscal deficit of the government, etc. The RBI did flag off the risks to inflation, but did not sound alarmist. Given that real interest rates (i.e. returns net of inflation) as of today is higher on the positive side as per historical standards, growth has just started to gather steam and there are large unutilized capacities in the manufacturing sector, the RBI is expected to maintain the neutral policy stance until there is any significant incremental risk to the economic scenario. On the proposed MSP hike, there is lack of clarity and it is early days to estimate the incremental impact on inflation.

The forward guidance of the MPC, which is known as ‘language’ in market parlance, may sound hawkish i.e. leaning towards rates hikes, as it did today. On inflation, though there are upside risks, the central target rate is 4% with a leeway of 2% on either side. That is, as long as inflation is within 6%, we are within target in a broad sense. In the inflation range from 4% to 6%, it is a matter of interpretation whether it is breaching the target. Today’s ‘language’ gives a hint that the RBI is taking a pragmatic view that 4% to 6% is a tolerable band, which is a relief to the markets. Hawkish ‘language’ need to translate to rate action, at least in the foreseeable future.

View on yield movement

Now that the policy review is behind us, the variables influencing yield levels in the market in the immediate future, apart from data prints like inflation, are (a) whether there is any support from the RBI to the market e.g. in the form of OMO purchases and (b) whether PSU Banks, who have not been participating in the market for some time which has led to a void in demand, come back to the market or not. In the absence of these two factors, yield levels may inch up little bit further, but the negatives have mostly been discounted by the market at the current levels.

(Joydeep Sen is the Founder of
Follow us on
Available On