Benevolent and balanced approach

The decision of the Monetary Policy Committee to keep unchanged the policy repo rate at 6 per cent has been in line with the expectations of all and sundry. In the lead up to the first bi-monthly monetary policy resolution of 2018-19, the attention of the analysts and experts shifted to the topic of what is going to happen in the rest of the fiscal year. An interesting survey of views and opinions of a set of leading experts published in the press earlier in the day revealed a bell-curve type dispersion of expectations on future rate actions of the RBI in 2018-19 ranging from a 25 basis points rate cut to a 50 basis points rate hike, with the median position for a 25 basis points rate hike.

The central message flowing out of this survey is loud and clear: continuance of the neutral stance for some more months with a good chance of a rate hike towards the end of the current fiscal. The G-sec market, which saw a sharp rebound in the latter half of March, saw decent rise in prices after the policy. The yield on 10-year G-sec firmed up by 11-12 basis points.  The equity market rallied by over one per cent after the policy, with the banking stocks making decent gains.     

The backdrop

The macroeconomic backdrop provided by the recent data releases indicates an end of the strong headwinds against growth caused by the demonetisation of 2016 and the GST roll-out of 2017. Amidst the lacklustre performance of the manufacturing sector in the fourth quarter of 2017-18, the services sector bounced back in March, 2018, raising a composite index that tracks the overall demand condition to 50.6 from 48.0 previously. The CPI in February came at 4.4 per cent, below the RBI’s projection of 5.1 per cent for the fourth quarter of 2017-18, but a shade higher than the medium-term target of 4 per cent. Excluding food and fuel, the CPI inflation remained unchanged in February at 5.2 per cent. An upward in credit growth has been witnessed in the recent months. 

Policy rationale

RBI expects the CPI inflation to have fallen further in March, 2018 on the back of lower food prices, with the projection for January-March quarter now pegged lower at 4.5 per cent. The projected CPI inflation for 2018-19 has been revised downwards to 4.7-5.1 per cent in H1:2018-19 and 4.4 per cent in H2, including the HRA impact for Central Government employees, with risks tilted to the upside. This is lower than the projection made at the time of the last bi-monthly policy in February: in the range of 5.1-5.6 per cent in H1:2018-19 and 4.5-4.6 per cent in H2, including the HRA impact, with risks similarly tilted to the upside. The expectations for a reasonably well-behaved CPI inflation in the months ahead appear to be two-fold: one, the recent broad-based moderation in food, and second, the forecasts of a normal monsoon this year.

RBI expects an acceleration in the pace of economic activity in 2018-19, principally on the basis of the signs of revival in investment activity and some growth in external demand.  GDP growth is projected to strengthen from 6.6 per cent in 2017-18 to 7.4 per cent in 2018-19 – in the range of 7.3-7.4 per cent in H1 and 7.3-7.6 per cent in H2 – with risks evenly balanced.

No scope for lowering the guard on inflation

Although the policy statement has comprehensively outlined the various upside risks to inflation, the majority opinion in the MPC seems to have judged that these are not as strong as to warrant a departure from the neutral stance.

But the CPI inflation moving lower towards the medium-term target of 4 per cent does not entail scope for any complacency in this regard. The inflation expectations of households, measured by the last round of survey in March, 2018 moved up for both three-month and one-year ahead horizons. Manufacturing firms covered in the Industrial Outlook Survey reported input price pressures and an increase in selling prices in the fourth quarter of 2017-18, which are expected to continue in the first quarter of 2018-19. Firms in the manufacturing and services sectors are now hiring at the fastest pace since June 2011 and their pricing power is also rising on the back of demand revival. The announcement of the new set of MSP as per the formula announced in the last budget may turn out to be a negative surprise for inflation. 

The regulatory initiatives

Mandating a minimum component of the working capital finance for large borrowers to be made available in demand loan form is very welcome. The main objective here seems to be to reduce the prevalence of the cash credit form of working capital finance, which not only creates liquidity management difficult for banks but engenders a need for the maintenance of excessive overnight liquidity in preference to liquidity for longer tenors.     

Allowing non-residents access to the Interest Rate Swap(IRS) markets in India is a path-breaking step in the sense that for the first time non-residents, in general, will be allowed to buy and sell a derivative instrument in India. Till now, NRIs and FPIs with underlying exposures are permitted to buy and sell the relevant derivatives. As a consequence, buying/selling in IRS and few other derivatives thrived in off-shore centres in ways that tended to dominate their on-shore market in India. It is hoped that this liberalisation will soon be extended to other derivatives, including the US dollar – Indian rupee forward foreign exchange contracts.

The proposal to study the desirability and feasibility of issuing digital currency by RBI is in line with the thinking of quite a few central banks. However, to the extent that transactions in  digital currency will not require a central counterparty for settlement they will be similar to cash transactions. This would sound a bit contrary to the current policy to reduce dependence on cash.

The decision to defer the introduction of Ind AS by one year on the pretext of delay in the preparation of the revised third schedule to the BR Act, 1949 reflecting the new accounting standard is an open admission of lack of seriousness on the part of all concerned. The banks were largely prepared, as evidenced by their success in preparing proforma quarterly financial statements as per Ind AS last year, as per RBI instructions. The real reason appears to be to avoid the extra provisions for loan loss that might be required to be booked by banks once Ind AS is introduced. It is not clear though, what real benefit will accrue to the banking system by this deferment? India will join the league of those countries which have failed to adhere to their self-announced deadlines for joining the global mainstream for accounting principles and rules.  

On the whole, this is a good and balanced policy. It provides further evidence that monetary policy-making under an inflation-targeting framework is taking root in India. This means, among other things, significant institutional progress and professional sophistication has been achieved by RBI. The policy statements are now focussed, logically articulated, meaningful and immensely readable.

(The writer is a former central banker and consultant to the IMF)