Ravi Krishnan
Investors did not buy the Reserve Bank of India’s (RBI’s) confident assessment of inflation, financial stability and the exchange rate. After the central bank’s monetary policy committee (MPC) held interest rates steady — contrary to widespread expectations of a 25 basis points hike — the rupee breached 74 to a US dollar before clawing back below 73, while the Sensex shed around 800 points or 2.25 percent of its value. Holding the rate steady while shifting the stance to “calibrated tightening” seemed to add to the confusion.
Clearly, the market would have preferred a more orthodox approach where the central bank hiked rates to support the rupee. The central bank instead adopted a textbook line: Both governor Urjit Patel and Deputy Governor Viral Acharya reiterated the MPC’s mandate was flexible inflation targeting and the interest rate is a policy tool to be used to achieve the 4 percent consumer price index inflation target.
In comments after the policy decision was announced by Patel, Acharya and Deputy Governor NS Viswanathan essentially brushed aside all other concerns. Their views are not without merit and supported by data. They reiterated that the exchange rate adjusts for changes in the terms of trade and they are concerned only with its volatility. Indeed, while the rupee fell 13.4 percent versus the dollar from January to September 2018 compared to 10.5 percent in 2013, India’s external position is more stable. The country has added close to $150 billion in forex reserves since then.
The MPC’s view that the policy rate is not the tool to defend the rupee also seems to suggest they are not overtly worried about the impact of the exchange rate (and even oil prices) on inflation. Their inflation projections are based on an exchange rate of Rs 72.5/$ compared to Rs 65.5/$ in April. Similarly, crude oil prices are projected at $80 a barrel in the second half compared to $68 in April.
Similarly, the RBI believes the liquidity situation is under control after announcing open market bond purchases of Rs 36,000 crore this month. IL&FS was described as an isolated incident which would not have a market-wide impact.
Then, all that is left is to look at is inflation. Here, the MPC has revised its projections downwards. CPI inflation is projected at 4 percent for the second quarter of this fiscal compared to 4.6 percent earlier. For the second half of this fiscal, projections have been cut from 4.8 percent earlier to 3.9-4.5 percent now. Similarly, for the first quarter of fiscal 2019-20, CPI inflation is forecast at 4.8 percent now from 5 percent earlier. However, these projections could be read another way as well. They are mostly still above 4 percent and thus the case could be made for another rate hike as panellist Chetan Ghate seems to have done.
The fact that the MPC listed several upside risks to inflation. For one, projections have been revised because of food prices undershooting projections. The impact from the implementation of minimum support prices (MSPs) remains to be seen. Oil prices remain a big risk as do volatility in global financial markets which are tightening after unprecedented accommodation in the last decade. Manufacturers are reporting increasing pricing power adding to price pressures. Lastly, the government’s cut in fuel duties, after buckling to populist pressures, raises the increased risk of fiscal slippages in an election year. These warrant a change in stance with the governor clearly saying the only options now are rate hikes or holding steady.
In the end analysis, the surprise decision to leave rates unchanged is RBI’s way of saying all is well. In any case, it was not as if a 25 basis points rate hike would stem the rupee’s decline. Indeed, the central bank lost some credibility through a series of panicky measures in 2013.
But these assessments and the message seems to have got “lost in translation”, as said by IndusInd Bank Chief Economist Gaurav Kapur.
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