The monetary policy committee (MPC) chose to retain the key policy rate, or repo, for the fifth time in a row on December 8. It came in line with the expectations of most economists. Earlier, all of the 10 economists and bankers who had participated in a Moneycontrol poll had predicted that the MPC will go for a status quo this time as well.
A rate cut, at this point, was off the table for a few reasons such as:
One, the MPC’s primary responsibility is maintaining price stability in the economy. High prices can impact all segments of life which, in turn, can boomerang on growth. In the current context, inflation worries are far from over. Although retail inflation has cooled off below the 6 percent tolerance limit in the recent months, the MPC is nowhere close to achieving its medium term target of 4 percent. In fact, the retail inflation has been above the medium-term target for 49 months. Without inflation easing more sustainably, it would have been risky for the policy panel to lower the guard.
Two, A potential resurgence in the inflation numbers is likely in November on the back of a spurt in food prices. It may break the easing trend observed through the last two months. The trajectory of food inflation remains crucial for the policymakers. According to Barclays economists, the rise will be driven primarily by higher food inflation, where the rise in prices of onions, tomatoes and other vegetables and persistence in few non-perishable items, pulses, in particular, is likely to push the headline inflation upwards. Typically, the RBI gets the data trend even before the inflation data is made public. Hence, a rate cut today would have been proved a mistake, prompting the MPC to take a cautious approach.
Three, the MPC probably wanted to see more effective transmission of the policy cues announced in the past. Without effective policy transmission, policy rate actions have no impact on inflation management - either by stimulating or by controlling the demand. As Moneycontrol reported in the past, Indian banks are yet to fully pass on the central bank's policy rate increases to customers. The lack of monetary transmission in the system has long been a concern for the central bank and has limited the impact of policy actions. While the RBI has hiked the repo rate by 250 bps in the last cycle, banks have passed on less than 200 bps to their customers. The MPC probably wanted to wait for better transmission of policy rates before acting further.
Four, The MPC has learned its mistakes from the past inflation management failure. Last year, the panel had to officially explain to the government its failure on inflation management. This was the first such instance since the formation of the MPC in June 2016. The MPC wouldn’t want a similar public embarrassment to happen. Calling an early victory on inflation and changing the rate course would prove to be another mistake for the MPC if inflation doesn’t fall as expected.
So, what’s next?
For those waiting for a rate cut, there may not be an immediate good news. It is likely that the MPC will continue with the pause mode till the first quarter of next fiscal to take a relook at the rate approach. That’s because the RBI typically does not take a call on the inflationary trend only with one or two months of data but wait for a few months to get a clearer pattern. Das emphasised this part in his statement on December 8.
Das said the monetary policy has to remain actively disinflationary to ensure durable alignment of headline inflation to the target rate of 4 percent while supporting growth and reiterated his caution on food inflation, saying it needs to be watched closely.
The upside risks to inflation are primarily from two factors - expected high food prices in the months ahead and a likely decline in agricultural production. Global factors such as geopolitical tensions, commodity upswings and interest rate movements overseas, too, could play out.
If these risks do not materialise, we should see the first rate cut by early next fiscal. It's a wait and watch till then.
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