RBI Hikes Rates: Monetary Reasoning

RBI monetary policy committee (MPC) unanimously decided to increase the benchmark repo rate for the first time in more than four years, in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 % within a band of +/- 2 %.

The rate changes after the MPC meet will be:

1.      Under Liquidity adjustment Facility(LAF) decided to raise Repo rate by 25 bps to 6.25%,
2.      The reverse repo rate under the LAF stands adjusted to 6.0 %, and
3.      The marginal standing facility (MSF) rate and the Bank Rate to 6.50 %.

Stance: Neutral

A neutral stance provides the Reserve Bank of India enough leeway to change rates in either direction in the next MPC. RBI Governor Urjit Patel said, “The MPC felt there was enough uncertainty to stick to neutral stance and yet respond to the risks to inflation target that have emerged in the recent months.”

A Rate hike was expected, but many experts felt that RBI might wait till the next MPC meet to hike Rates. This rate hike is being treated by some as a pre-emptive strike to insulate from the event risk on inflation in the future.

The major factors taken into account by the committee on deciding for a Rate hike were:

1.      Rising inflation concerns: The committee expects retail inflation at 4.8-4.9% in the first half of the year and at 4.7% in the second half of the year. Retail inflation, which is targeted was 4.58 % in the month of April, driven by a significant increase in inflation excluding food and fuel.                                                                                                                                (source: RBI)

2.      Global Factors: Global trade growth has continued to strengthen, though geo-political tensions contributed recently to declining export orders.  In Advanced Economies the Global economic activity has expanded albeit some momentum has been lost; Emerging Market Economies have generally been resilient. Oil prices increased for some period and the due to supply glut more or less stabilized.

3.      US Rate Cuts: This has increased the pressure on the Indian Rupee. Also, bond yields have risen on reduced foreign appetite for Emerging Markets debt due to growing dollar shortage in the global market and on prospects of higher interest rates in Advanced Economies. Stocks in major EMEs have faced sell offs on a rising dollar.

4.      Liquidity Surplus: During April, the Reserve Bank absorbed surplus liquidity of ₹496 billion on a daily net average basis due to increased government spending, especially in the second half of the month.

5.      Rural Demand: Improved rural demand on the back of a bumper harvest and the government’s thrust on rural housing and infrastructure. The monsoon forecast augurs well for the agricultural sector. According to RBI, October seems more likely by which better information about the impact of the MSPs on food prices can be gauged. As forecast by the IMD, if the monsoon is normal and well-distributed temporally and spatially, it may help keep food inflation in check.

Economic Survey 2017-18:Underscoring the pink

The Economic Survey 2017-18

The Economic Survey provides us with analytical overview of how the economy has fared in the previous year, which in turn acts as a guiding light for the government to chart its path for the next fiscal year. The survey is also used by laypersons to understand the general direction of the economy.

The Economic Survey for the 2017-18 was tabled in the parliament on 29 January 30, 2018. This year’s survey was presented in Pink colored booklets to highlight its support for movements to end violence against women.  It was also the second time in history when Big Data Analytics was effectively used to provide insights for the survey.

Following are the major highlights on the state of the economy as described in the survey:

1)  The Economic Survey predicts the GDP growth for FY2017-18 to be at 6.75% YOY, the average GDP growth rate after 2014 has been 7.3% YOY which is highest among the major economies.

2)  For the coming FY GDP growth is predicted to be at 7-7.5% YOY, the survey argued that this growth will be supported by:

1. Revival of global demand
2. Impact of shocks like demonetization and GST to the economy will smooth over time

3)   Introduction of GST has led to a direct increase (50%) in number of indirect            taxpayers.

4)    India has jumped 30 spots to reach top 100 in the ease of doing business ranking, which is a sign that more foreign and domestic investments can be expected over time.

5)    Survey highlights the steps taken by the government to resolve the “twin balance sheet problem” by:

1.  The increase in recognition of stressed assets
2. A bank recapitalization package amounting to approximately 1.2% of GDP 
3.  By implementation of the asset resolution process as mandated by the Insolvency and Bankruptcy Code (IBC).

6)    The survey acknowledges the twin balance sheet problem as the “festering, binding constraint” on growth.

7)    The story of revival in the Survey is not without warnings of risk factors within the economy. A key risk in the upcoming fiscal arises from the rise in oil prices.

8)  The second major risk as highlighted in the Survey, which can impact India's growth, is a possible correction in the stock markets. As the Survey points out, a sharp correction cannot be ruled out in case future growth of the economy and corporate earnings do not remain in line with current expectations.

Concluding Remarks:

In conclusion, the outlook for 2018-19 will be determined by economic policy in the run-up to the next national election. If macro-economic stability is maintained and the ongoing reforms are stabilized, and the world economy remains on a revival path, growth could start recovering towards around 8 percent in the medium term.

Putting all these factors together, a pick-up in growth to a range between 7% and 7.5% in 2018-19 can be forecasted, re-instating India as the world’s fastest growing major economy.

The biggest source of upside potential will be exports. If the relationship between India’s exports and world growth returns to that in the boom phase, and global growth for 2018 is in line with IMF projections, then that could add another 0.5% point to the national GDP.

Against this overall economic and political background, with general elections coming up next year; policy formulation will be challenging in the coming year. The obvious threats (such as fiscal expansion) still have to be avoided and the risks well mitigated by fiscal prudence and planning, for India to achieve its full potential. All this has to be done while ensuring that the rural demand picks up and corporate earnings increase, so the government has to tread a fine line and come up with a balanced budget.

Note To Readers: Due to some academic constraints I, Anurag Dubey, was unable to publish new blogs since August last year. I will try to publish more this year. This blogpost has been co-authored with Prasad Pansare.
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