INSUBCONTINENT EXCLUSIVE:
By Saugata BhattacharyaA need for the forward-looking component of monetary policy to credibly lower rising inflation expectations probably
overrode the slowdown risks in the current uncertain economic environment
The Monetary Policy Committee (MPC) voted 5 to 1 to hike the repo rate by 0.25% to 6.5%, while maintaining a neutral stance
Even at the risk of seeming inconsistency of two consecutive rate hikes amid a neutral stance, the MPC opted to frontload its tightening,
aware that a temporary phase of easing inflation might constrain rate hikes over the next few months.
What changes since the June review
Of possible greater significance in the voting were internal RBI surveys
The first showed that household inflation expectations have risen significantly in the last two rounds
The second showed hardening of input price pressures for manufacturing firms
Both have the potential to influence actual inflation over time.
The path of rate actions going ahead is likely to be shaped by inflation
elucidated are almost all on the upside
The extent and pace of closure of the remaining output gap, indicating attendant rising demand, and consequent corporate pricing power, will
So will the potential expansionary impulse from fiscal slippages, both of the Centre and states, although the Government of India has
committed to fiscal rectitude.
Given this outlook, the language and tone of the policy were unexpectedly moderate
Our assessment is that inflation is likely to average 4.7% over the rest of FY19 and 5.0% in FY20
Although not alarming, the path does remain persistently above the target 4.0%
Combined with the ambient economic uncertainty, this also explains the retention of the neutral policy stance, allowing a quick change in
direction as warranted by circumstances
However, the ongoing growth recovery suggests that interest rates are firmly on a rising curve, although the near-term inflation path
suggests a longish pause in rate hikes.
The key question now is the intensity of transmission of the policy rate hike to bank (and to an
extent market) lending rates
Rising lending rates, rather than market yields, is a bigger concern in choking the nascent investment recovery
RBI has hitherto efficiently calibrated system liquidity both to keep overnight and near-term rates close to the policy rate while infusing
enough durable funds to provide comfort to banks that tenor and rate mismatches do not lead to a sharp rise in cost of funds and
subsequently lending rates
This liquidity can be expected to tighten in coming months, and managing this will be key to maintaining interest rates at levels
appropriate for the growth- inflation tradeoff.
(Author is chief economist, Axis Bank.Views are personal
