RBI Springs a Surprise

The Reserve Bank of India surprised the market by keeping the policy rate unchanged as it lowered inflation forecasts, despite a surge in crude oil prices and the financial markets in panic mode. But it shut the door on any rate reductions in the months ahead by shifting its stance to ‘calibrated tightening’ from ‘neutral’.

It ruled out any special measures to arrest the slide of the rupee, which has plunged to historic lows along with other emerging markets currencies, and reiterated that any intervention would be to avoid excessive volatility rather than targeting a specific level.

While promising sufficient liquidity in the financial markets, the central bank was critical of the asset-liability mismatch at non-banking finance companies and suggested that they raise more equity and long-term funds rather than focusing on profitability with short-term funds that create instability. That follows the turmoil sparked by Infrastructure Leasing & Financial Services defaulting on payments.

Having raised the repo rate, at which the Reserve Bank lends to banks, at the two previous reviews, the central bank left the benchmark unchanged at 6.5%. All other rates were also left undisturbed. The six-member monetary policy committee voted for the status quo on rates and to change the stance by 5-1.

The monetary policy did little to calm market jitters. The benchmark Sensex tumbled 2.25% to 34376.99 points, the rupee lost 0.26% to a new closing low of 73.77 and bonds rallied, with yields falling 13 basis points. Bond prices and yields move in opposite directions. One basis point is one-hundredth of a percentage point.

While the market has been worried about a possible spike in inflation due to the sliding currency and a surge in crude oil prices, the central bank believes benign food prices will help the overall reading to be lower. It cut the inflation projection to 3.9-4.5% for the second half of FY19 and to 4.8% for first quarter of FY20. In its previous forecast, it had said inflation would be 4.8% in the second half of this fiscal and 5% in first quarter of the next fiscal year.

But it admitted to upside risks to its forecasts given the uncertainty over crude prices.

The Reserve Bank of India is mandated to keep retail inflation at 4% with a band of two percentage points on either side. The change in stance means that a rate cut is no longer on the table — RBI can either raise rates or keep them unchanged.

Retail inflation cooled to an 11-month low of 3.69% in August, mainly due to a fall in the prices of food items, including fruit and vegetables.

The rupee has slipped about 5% since the last monetary policy while oil prices have risen 10%, swelling the current account deficit from 2.4% in the June quarter to a projected 2.8% in three months ending March 2019. The financing of deficits will be a challenge with dollars exiting the country.

Foreign portfolio investors have sold securities worth a net ₹61,497 crore this year, according to data from the National Securities Depository. They had invested in excess of ₹2 lakh crore in 2017.

While many emerging markets such as Indonesia and Turkey have raised rates sharply, India has been an outlier as it is believed to be letting the currency depreciate since it has been relatively overvalued in the past two years, stifling exports.

Pami Dua, Ravindra Dholakia, Michael Patra, Viral Acharya and Patel voted in favour of keeping the policy rate unchanged. Chetan Ghate voted for an increase by 25 basis points. Dua, Ghate, Patra, Acharya and Patel voted to move to calibrated tightening, while Dholakia wanted to stick with the neutral stance.

The next MPC meeting is scheduled for December 3-5. The minutes of the October meeting will be published by October 19.

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