Clarity emerges on monetary policy stance

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The penultimate monetary policy for fiscal 2018-19 has maintained status quo on the policy repo rate at 6.5 per cent, but what stands out is the clarity with which the MPC resolution and the RBI leadership has spoken this time on critical areas like liquidity, volatility in retail inflation, growth outlook and the usage of monetary policy instruments.

The MPC resolution has set out a lower retail inflation outlook (2.7-3.2 per cent in H2 of 2018-19 and 3.8- 4.2 per cent in H1 of 2019-20) measured in terms of Consumer Price Index (CPI). However, the growth outlook has been kept at 7.4 per cent for 2018 -19 and 7.5 per cent in H1 of 2019-20. But when the retail inflation outlook looks benign and is below the average inflation target of 4 per cent, why has the policy rate not changed? And, more importantly, why has the monetary policy stance also not changed from “calibrated tightening” to “neutral”, as indeed, one of the MPC members had suggested?

The MPC has looked beyond the headline numbers. The critical factor is not the lower level of food and fuel inflation but the volatility associated with food and fuel prices. There is a possibility of a “sudden reversal” as the “prices of several food items are at unusually low levels”. Besides, there are uncertainties on the inflationary impact of minimum support price and also on the medium-term outlook of crude oil prices.

Inflation management

More importantly, inflation management is more about anchoring of inflation expectations. The household inflation expectation survey by the RBI in medium term perspective has remained on a higher trajectory. There is the added risk of fiscal slippages in what is an important election season.

Core inflation has remained sticky and is also at a higher level. More importantly, the output gap, according to the MPC resolution, is virtually closed, implying that the economy is operating at its potential level. In view of the foregoing, the MPC has taken a sound, well-calibrated decision to keep the policy repo rate rate unchanged.

When the MPC resolution is seen in conjunction with RBI Governor Urjit Patel and Deputy Governor Viral Acharya’s statements, a few important points emerge on liquidity management.

First, there is a clear distinction between durable liquidity and frictional liquidity and the RBI has used Open Market Operation (OMO) purchases for addressing durable liquidity to the extent of ₹36,000 crore and ₹50,000 crore in October and November 2018, respectively. It will further take recourse to ₹40,000 crore OMO in December 2018.

To meet the frictional liquidity challenges, the RBI has taken recourse to term repo of various maturities on a daily basis and the amount aggregated to ₹1.471 lakh crore in October, November and up to December 4, 2018. Second, the RBI has said it is committed to transparent and market-related instruments like OMO and term repos where the interest rate is market determined in contrast to the Cash Reserve Ratio, which is a non-market monetary policy instrument.

Third, as clarified by the Governor, changes in CRR are not under the purview of MPC. This is an important clarification for market participants. In this context, it is important to mention that for the benefit of the banks and market participants, the RBI has decided to publish the CRR balances on a daily basis with a lag of one day, as is the case with the money market rates.

It is heartening to note that the latest non-food credit growth at 15.3 per cent is higher than the current nominal GDP growth rate. This development is critical as credit flow oils the wheels of economic growth. Furthermore, the RBI decision to align the Statutory Liquidity Ratio (SLR) and Liquidity Coverage Ratio (LCR) will help banks increase credit flow to the economy.

There are broader questions on how the Indian economy can break past the seven plus per cent potential growth and move to a higher level? How will the retail inflation rate be maintained at the mandated level of average four per cent and what are the downside risks to the interest rate scenario with frequent OMO purchases?

To move to a higher growth rate, the financial savings rate needs to move to a higher trajectory with a durable full stop to government dis-savings. While fuel price volatility is largely exogenous, food inflation management and service inflation management are critical and these are for the RBI and the government to manage. OMO purchase and debt management need to be coordinated in terms of timing and volume of government borrowing and OMOs. At the same time, we need prudent management of fiscal policy not only in terms of lower fiscal deficit but also with zero revenue deficit and zero fiscal slippage.

The writer is a former central banker and faculty member at SPJIMR. (Through The Billion Press.)



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