Rajan’s last policy

As usual, the policy was pragmatic and data driven…

The August 09th monetary policy had the stamp of Dr. Rajan written all over it. It was pragmatic and as usual the RBI governor was driven more by the reality of the situation. The next policy will be announced by the new governor on October 04th and will most likely be driven by the Monetary Policy Committee (MPC). Here are some of the key takeaways from the policy…

Focus on inflation to stay…

 The best vindication of Rajan’s focus on inflation came when the Finance Ministry also acknowledged that the Indian economy will target 4% inflation in the medium term. The RBI governor has been typically loath to cutting rates when there were upside risks to inflation. With CPI inflation coming in at 5.77% and hovering around its 18-month high, the RBI had little choice but to maintain status quo on rates. The RBI’s argument is that if CPI can be so high with crude below $50/bbl, then there are distinct upside risks to inflation if the crude oil prices start moving up. The key theme of the policy seems to be that even after the governor changes, the focus on inflation targeting will continue at the RBI.

Unhappy with transmission…

 One of the reasons the RBI has been skeptical about rate cuts is that transmission has been quite poor. Bankers have only passed on about 55% of the rate cuts since January 2015 to the end borrower. While most banks have blamed the liquidity concerns for the same, the real reason seems to be the unwillingness to pass on the entire benefit to the end customer. The RBI has made it clear that further rate cuts are unlikely if transmission is not satisfactory. Here again, the focus on transmission will continue even after the person at the helm of the RBI changes.

Liquidity is the key…

Management of liquidity has been the key for the RBI and will continue to be the key. The government has infused liquidity to the tune of Rs.80,000 crore in this fiscal through OMO purchases. The liquidity deficit has been brought down to 1% of NDTL and is likely to be slowly prodded towards the neutral level. This infusion of liquidity has been instrumental in bringing down the yields at the short end of the yield curve. This has ensured that returns have been attractive at the short end and also the yield curve is getting back to normal upward slope.

During his tenure, Rajan has managed to shift focus from rates to liquidity. That strategy is likely to continue. Rajan also started the calibrated management of the rupee as well as intervention in forex markets through derivatives. These are legacies future RBI heads will most likely carry on. Rajan surely leaves the Indian economy on surer footing! ©

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