Pause for now

Monetary Policy Review


Our view


In its monetary policy review in December, the MPC had halted the rate cutting cycle and sought more clarity from incoming macro data – especially the fiscal stance of the government – for future monetary policy decisions.


Three important developments since then:


  • CPI inflation – managing which has been the overarching objective of our inflation-targeting central bank – reached a 65-month high of 7.4% in December. While this was largely on account of food inflation – a transitory factor – it crossed the upper mark of RBI’s 2-6% inflation target for the first time, giving reason to worry.
  • The Union Budget veered off its fiscal consolidation path by 50 bps, both for this fiscal and the next, printing at 3.8% and 3.5%, respectively. This, we believe, will not be inflationary.
  • Outbreak of coronavirus, which can impact tourist arrivals and global trade, and therefore has adverse implications for growth.

We believe, given the current inflationary pressures, the RBI’s cautious stance was prudent and on expected lines. While an unusual surge in some vegetable categories seems to be correcting, prices in some other food categories seem to be firming up. At the same time, increased telecom prices and current hike in import duties in some consumer goods would mean some upward pressure on core inflation.


Moreover, there is still ample scope of the monetary transmission of the previous rate cuts (that credit growth remains low despite banks being flush with funds indicates inadequate transmission). In the context, today’s monetary policy scores by introducing a number of innovative steps – adoption of new liquidity framework, introducing LTRO, incentivising banks to lend more to productive sectors of the economy, and extension of One-time Restructuring Scheme for MSME advances, etc. – which will help speed up monetary transmission, improve credit flow and help address the NPA problem to an extent.


But what about future monetary policy action?


To be sure, even though the government has decided to breach the fiscal deficit target, it is not too growth supportive (please refer to our budget analysis for more on this). At 6% GDP growth, the economy is expected to remain below potential in the coming fiscal. This implies that once the inflationary pressures show clear signs of easing1, the MPC will resume the rate cutting cycle, especially as it continued to retain its accommodative monetary policy stance in today’s meeting. In fact, the MPC statement categorically mentioned “there is policy space available for future action”. This, along with regulatory changes announced today with respect to providing adequate durable liquidity, will also help assuage bond yields.


1 It is important to note that household inflation expectations which had shown a sharp pick up in the previous round have once again eased as per the latest January 2020 round: three month and one year ahead household inflation have fallen by 60 and 70 bps respectively.