The policy landscape in India has undergone a sea change in recent days. The RBI mid-quarter policy statement welcomed the change and provided some support by reducing the cash reserve ratio (CRR) by 25 bps.
What was particularly important was the subtle change in monetary policy stance. In July, RBI had said “lowering policy rates will aggravate inflationary impulses, without necessarily stimulating growth”. The September guidance that “monetary policy has an important role in supporting growth revival” is a departure from the July statement. This creates the expectation of a policy rate cut soon, but the inflation trajectory and more measures to control the fiscal deficit would be watched before RBI delivers on this. A coordination between fiscal and monetary policy may be on anvil.
The recent fuel price rise may push WPI beyond the eight per cent mark in the coming months. Since this effect is known, we will not be surprised if RBI’s focus shifts back to core inflation or some index that weeds out the transitory effect of the diesel price rise. Core inflation has also nudged up in the August reading but a combination of slow growth and a firming currency should theoretically bring it down. However, we also worry about the persistently high inflationary expectations and how these might be impacted by the recent fuel price increases. Any material shifts in inflation expectation could force RBI to take a more cautious stance.
While RBI has been reluctant to bring down the cost of liquidity, it has been more comfortable in raising the liquidity quantum. After OMO in the first quarter and a cut in SLR in July, this time it was a CRR cut. Although the LAF has remained within RBI’s comfort zone, lower than targeted M3 growth could have prompted the CRR cut. Banks would welcome a CRR cut and the term premium at the short end of the curve might ease but bond traders would be worried that a CRR cut could imply lower OMOs.
Samiran Chakraborty
Regional Head of Research (South Asia) Global Research, Standard Chartered Bank
