RBI Monetary Policy: Rates Unchanged, But its Stand is Dovish

The Reserve Bank of India held its key policy rate steady at 7.25%, but its monetary stance was seen as more dovish.

Key Points

• The Reserve Bank of India held its key policy rate steady at 7.25%
• RBI’s monetary stance is seen as more dovish
• Pause in monetary easing has disappointed corporate India
• Global growth projections for 2015 have generally been revised downwards
• The RBI has lowered inflation projections for January-March 2016 by about 0.2%

The Reserve Bank of India held its key policy rate steady at 7.25% today, as widely expected, but its monetary stance was seen as more dovish, as compared to the June policy review when it announced a 25 basis points cut. The pause in monetary easing, however, disappointed corporate India, which felt continued front-loading of interest cuts would have helped restore investment cycle and aided growth.

Further easing will depend on inflationary pressures in the economy and the speed at which commercial banks pass on the 75 basis point cut the RBI has made since January this year. The RBI notes that the median base lending rates of banks had fallen by around 30 basis points only so far. The impact of an imminent increase in interest rates by the US Fed on global markets will also weigh on the RBI’s stance on its policy rates.

Economists and analysts remain divided on whether there will be any more rate cut this fiscal year, although there is unanimity that the Bank has turned dovish. This is because the RBI remains worried about hardening of inflation reflected by the rise of consumer price index (CPI) in June. The impact of an increase in service tax, which came into effect from June, is yet to fully play out. Yet, the governor did not rule out further easing of interest rates, even mid-cycle, if conditions tuned favourable.

CPI Will Remain the Inflation Gauge

RBI Governor Raghuram Rajan explained at a post policy press conference that CPI was a better gauge for monitoring prices than WPI as it captured inflation in services and also reflected inflation caused by domestic factors. In contrast, the WPI basket comprised commodities that were experiencing disinflation or deflation due to global conditions, he said, ruling out reverting to WPI as the preferred gauge for monitoring inflation. Other than services, WPI does not take into account non-traded commodities, and that too contributes to making it a less efficient tool to measure the inflation. The difference in composition of the basket of items for CPI and WPI is responsible for the widening divergence of WPI and CPI.

Earlier, in a statement on monetary policy, Rajan listed four factors that will condition monetary policy actions. These are:

Fuller transmission of RBI’s front-leaded rate reductions in commercial bank lending rates,
Food prices and their management given the shortfall in monsoon rains,
policy’s efforts to restart stalled investment and
Signs of normalisation of the US monetary policy

Crude Oil has Mitigating Influence

Rajan acknowledged there were many positives for the economy. The easing of crude oil prices following the lifting of sanctions in Iran and continued over-supply, the increase in planting of pulses and oilseeds, better than anticipated rainfall, proactive measures to keep food prices in check and moderate increase in minimum support prices, all promise to rein in inflation pressures.

These factors would translate into improving the outlook for growth, the RBI statement notes, adding that:

Real income effects could accrue from weaker commodity prices, in particular crude oil, and possible step-up in agriculture activity if monsoon conditions continue to improve.

Guarded Approach

The monetary policy also took note that global growth projections for 2015 have generally been revised downwards and, therefore, India’s exports continue to contract. That will be a drag on growth, considering that global trade has a significant share in India’s GDP. It has also noted that the economy continues to suffer from supply constraints and subdued investment demand from the private as well as the government sector. Yet, it has retained its estimate for GDP growth at 7.6%.

The RBI has lowered inflation projections for January-March 2016 by about 0.2%, and inflation is seen around the target of 6% for January 2016 due to softer crude prices, prospect of good pulses and oilseeds crop and measures taken by the government to check prices. But, RBI is expected to consider inflationary pressures over the next 4-6 quarters before easing policy rates any further.

(The writer is a Delhi-based senior journalist)