Surprising move by RBI

The Monetary Policy Committee of the Reserve Bank of India, in its fourth monetary policy statement for the fiscal year 2018-19, kept the interest rate unchanged and changed its stance from 'neutral' to 'calibrated tightening'. 

This call was a surprising one, as economists were expecting a 25 basis point rate hike. The MPC seems to focus only on its inflation-targeting mandate even as the Rupee's free fall continues to spook investors. It is said the six-member MPC voted 5-1 to keep the repo rate unchanged at 6.5 per cent. 

Interestingly, government appointed member was the only one of the six members to vote for a 25 basis points increase in the policy rate. Many banks are expected to reset their lending rates over the next few weeks to align them with RBI's two previous interest rate increases. In addition, the stance of 'calibrated tightening' may force banks to keep their hands on the interest rate lever. 

The move has surprised markets by the status quo on rates because it is at variance with global central bank rate actions. Markets were also disappointed with the policy statement failing to include any concrete measures to stop the relentless fall in the value of the rupee or providing a healing touch to the systemic instability posed by non-banking finance companies (NBFCs). 

Despite the stand of the RBI, the changed stance has increased the possibility of further rate hikes, with inflation data being the deciding factor. The key risks to domestic prices come from volatile global financial markets, surging oil prices and possible fiscal slippages in the run up to elections. The inflation outlook certainly calls for a close vigil over the next few months, especially because the output gap has virtually closed and several upside risks persist. 

There are, however, concerns on a possible growth slowdown on account of several headwinds, including high oil prices, volatile global financial markets, intensifying trade wars and growing uncertainty in the domestic financial landscape. Anyway, the decision by the MPC to pause on policy rates comes at a time when liquidity conditions have tightened and there are worries that defaults by Infrastructure Leasing and Financial Services Ltd (IL&FS) could lead to a congestion.

 While not losing sight of the inflation mandate, the 'flexibility' allows the MPC to respond to other important objectives like financial stability, extremely relevant to the RBI's role as a full service central bank. Some questions remain here. Granted, inflation, at a time 3.7 per cent does not really justify a rate increase. 

But, the current-account deficit, set to breach 3 per cent of GDP in this fiscal year, is above the danger mark. Anyway, the door still remains open to rate hikes, despite our worst performing rupee. It is still expected that the RBI may hike rates later this calendar year. 

All eyes will now be on next RBI's MPC meeting scheduled for December 5.  Let us hope for the best.