Monetary Policy Committee Meeting: Rates unchanged; stance shifts from ‘accommodative’ to ‘neutral’

Monetary Policy Committee Meeting: Rates unchanged; stance shifts from ‘accommodative’ to ‘neutral’ The Reserve Bank of India (RBI) kept its key policy rate — the repo rate — unchanged at 6.25 per cent on Wednesday citing global uncertainties (अनिश्चितताओं) and the need to be flexible in an uncertain economic environment.  This will mean effectively signalling no rate cuts in the near term.

The Monetary Policy Committee of the RBI which met here on Tuesday and Wednesday said that the RBI was changing its monetary policy stance (ठान) from accommodative to neutral — which implies that the current rate cycle has peaked and there is little space for an incremental(वृद्धिशील)  fall in interest rates. However, RBI Governor, Urjit Patel said that there is still room for lending rates to fall since banks have not fully passed on the 175 basis points cut in the policy rate to their customers. “The Committee remains committed to bringing headline inflation closer to 4.0 per cent on a durable basis and in a calibrated manner. This requires further significant decline (पतन) in inflation expectations, especially since the services component of inflation that is sensitive to wage movements has been sticky(चिपचिपा) . The committee decided to change the stance from accommodative to neutral while keeping the policy rate on hold to assess how the transitory (अस्थायी) effects of demonetisation on inflation and the output gap play out,” said the monetary policy statement. 

All six members of the monetary policy committee (MPC), who decided whether interest rates should be raised or lowered  voted unanimously (सर्वसम्मति से) to keep the policy rate unchanged. This was a surprise to the markets which had expected rates to come down by at least 25 bps given the consumer price inflation had touched 3.41 per cent in December. However, Governor Patel said that if vegetable prices were excluded, the inflation number would be 1.4 percentage points more than the headline number. The MPC noted that there were key risks to inflation going forward and it also expects growth to bounce back in the next financial year. Deputy Governor, Viral Acharya said that given the risk of sticky non-food component of  the Consumer Price Index or CPI and global uncertainties, as an abundant (विपुल) precaution, the RBI  had decided to ensure that it had all the flexibility to deal with emerging economic policy challenges.

The three key risks to inflation highlighted were: Rising international crude prices, exchange rate volatility because of global financial market developments which could lead to imported inflation and the full effects of the house rent allowance increase under the seventh central pay commission, which has not been factored so far.

In any case, the MPC believes that growth too will recover because discretionary consumer demand suppressed by demonetisation will bounce back, and remonetisation will spur economic activity in cash intensive sectors such as retail trade, hotels and restaurants as well as the unorganised sector. Moreover, the reduction in the marginal cost of funds lending rate (which has happened because banks are flush with deposits) will also spur a pick-up in consumption and investment demand, the MPC resolution said.

“Since RBI has changed its stance from accommodative to neutral, the prospects of further cuts in policy rate in near future have receded. Clearly, the primary objective of inflation targeting has played a major role here as the move seems to be wary of hardening global commodity prices, strengthening USD and stickiness in domestic core inflation,” said Melwyn Rego, managing director and chief executive, Bank of India.

For consumers, any fall in lending rates will now come from banks transmitting the rate cuts that have already happened. The MPC said this can happen if the bad loan problem of the Indian banking industry is resolved quickly, there is speedy recapitalisation of bank capital and if the small savings schemes interest rates are fully attuned to changes in government bond yields.

The RBI said it is not dogmatic about setting up a bad bank to deal with non-performing assets but is open to all solutions for resolving the current stressed assets situation.

“I think we have to remain open to all solutions at this point because I think the problem is quite large. I don’t think a bad bank just by itself will necessarily work. It has to be designed right. The big piece of the problem is can you get the banks to sell the assets at the right price to ARCs and private investors who want to come in , how get the right price to come in using a portfolio or a bad bank kind of approach is going to be key,” said Deputy Governor, Viral Acharya.

“The policy announcement is in line with expectations. The RBI has rightly indicated that it would watch growth trends, the fiscal approach that is articulated in the Budget, factors impacting inflation while also making room for inclusive growth policies in the coming months. Overall, the policy statement is a comprehensive and a well-balanced articulation of inflation projections at less than 5 per cent and GVA at 7.4 per cent,” said Ashwani Kumar, chairman and managing director, Dena Bank.