Gujarat polls, a deciding factor for RBI's future move

Yet another monetary policy of the Reserve Bank of India (RBI) has come and gone raising hopes and despair in a large section of society. This time the policy was majorly on expected lines. It did not change much from the last one, handed out no surprises and therefore many called it a non-event.

And the policy discussions immediately shifted to the nuanced tone of the future guidance by the central bank which left a lot of scope for interpretation. The Monetary Policy Committee (MPC), which arrived at a decision to maintain a status quo on policy repo rate at 6% and consequently a reverse repo at 5.75%, said that it maintained a neutral stance and would watch the incoming macroeconomic data carefully to arrive at any decision on whether to give a rate cut or hold on to the current situation for more time.

The neutral stance was interpreted differently by different stakeholders. The government interpreted it to suit its own definition, the industry and other economists and analysts gave a different viewpoint. In fact, the idea of the RBI in choosing the nuanced 'neutral stance' appeared to leave the guessing game on till it came up with the next policy review.

The Finance Ministry, immediately after the monetary policy, issued a statement saying that the government had taken a note of the MPC recognising inflation remains firmly under control, retaining its inflation projection for the second half of FY2018 and assessing that the risks to this projection are evenly balanced.

For that reason, it has maintained a neutral policy stance. Others interpreted the policy as one which came on the back of a high inflation, and estimated that going forward, inflation was going to be stickier, and hence, the neutral stance gave the RBI enough freedom to hold on rates even in the near future.

But the fact that the RBI has increased its baseline projection of inflation from 4% to up to 4.7% clearly suggests that it does not believe either on inflation being firmly under control or it softening anytime in the near future.

In the last policy in October too, the statement projected inflation to rise in the range between 4.2% and 4.6%. In fact, the structural reforms that the government has undertaken in the past one year could be disruptive on the growth side in the near future and fan inflation, a fact that the government may try to disown, but the central bank is well aware, and hence, the neutral
stance.

The oil prices have been on the rise since the last policy review in October, inflation has inched so close to the RBI's original projection of 4% that it had to revise the baseline upward. The fiscal position of the government is not all that sound there are pointers which suggest towards a slippage this year.

Amid all that the central bank may not have wished the markets to send disruptive signals and investors to withdraw, and hence, it maintained a stance which neither says yes nor says no. The RBI has, however, said that it will carefully monitor a few key indicators before deciding on the next course of action.

First, food and fuel inflation, that have edged up in November. Inflation expectations of households surveyed by the Reserve Bank have already firmed up and any increase in food and fuel prices may further harden these expectations. Second, rising input cost conditions as reflected in various surveys point towards higher risk of pass-through to retail prices in the near term. Third, implementation of farm loan waivers by select states, partial rollback of excise duty and VAT in the case of petroleum products, and decrease in revenue on account of reduction in GST rates for several goods and services may result in fiscal slippage with attendant
implications for inflation.

The caution is worth taking note of. In fact, quite contrary to the government's expectations, the whole narrative on future interest rates trajectory may change and the entire 2018 may see a hold on rates if the BJP loses Gujarat elections. The chances of that are dim, but if it happens, the whole policy stance of the government is expected to change its course and tilt towards a populist one in the run-up to 2019 General Elections. That will lead to more fiscal slippage and of course be inflationary.

The RBI has already sounded a cautious note on farm loan waivers impacting the Central and state governments' revenues. A possible rise in global crude oil prices is another risk to India's inflation and therefore its growth. The RBI would watch these factors too before arriving at a decision on its future course of action. The Central bank may not have cut the economic growth forecast this time, but if the above become real, it may revise the GDP forecast downward too.