The August monetary policy was not on the same plane as the June policy. Ahead of the June policy there was a virtual unanimity that the RBI would hike rate by 25 basis points. Inflation had gone up sharply and neither crude nor food inflation was giving any respite at that point. Additionally, the rupee was facing the brunt of rising inflation and the only way to stem the fall of the rupee was to hike the interest rates. But the rupee and the bond yields were much more stable in August. It actually surprised the street that the MPC did not wait for the Fed policy and the impact of Kharif MSP. So, why exactly did the MPC again hike by 25 bps?
Real rates were the concern…
While the final minutes of the Monetary Policy Committee (MPC) will only be out in the third week of August, one thing that emerged was the discomfort of the MPC with the real interest rates. At the current level of inflation, the real interest rates stood at 1.25% against the RBI target of 1.75%. That was a huge gap and had to be filled up to avoid aggressive outflows from Indian capital markets. The second point that emerged from the MPC discussions was that 5 out of the 6 members were still worried about sticky inflation as the big threat. Oil prices were still uncertain but food inflation posed a bigger threat if the higher MSP to farmers really had a downstream effect. Thus the rate hike was more a pre-emptive measure!
Inflation and growth guidance…
The key data point that guides the RBI and the MPC is the expected inflation rather than the historical inflation. The expected inflation is likely to stay above the 5% at least till the middle of 2019, at which point the situation could turn more challenging as the election flow also start impacting inflation. The expected inflation is likely to cover the impact of geopolitical uncertainty, food prices and the lag effect of phased HRA payouts by the government. GDP growth is likely to get back to above 7.5% indicating that calibrated rate hikes are going to have limited impact on economic growth. Of course, the demand-pull impact of growth on inflation has not yet been factored in.
Did MPC push it through?
The question is if the MPC pushed through the rate hike in a hurry. More so, considering that the US Fed chose to maintain status later in the night. The MPC has actually adopted the right approach. By hiking rates and keeping the monetary stance at Neutral, the RBI has given an indication that the rate hike was front-ended. If the impact of MSP is too little, the RBI is left with a lot more fire power to play the monetary tweaking either ways. This pre-emptive move has brought down the G-Sec yields, stabilized the rupee and made Indian equities more valuable. Front-ending may actually work for RBI! ©
