'Pragmatic' Urjit Patel brings shift in monetary, banking policy management

Urjit Patel moved to the corner office at RBI in early September on the plank of continuity in policy regime. Yet, the first policy review under him has shown that the Central bank governor is looking at a clear shift in managing monetary and banking affairs.

In its report on the policy statement, Citigroup suggests that there has been a major rethink on inflation, real interest rates and the growth trajectory. In a research note, Citi notes four key departures in the RBI statement this time around.

First, while the RBI does note that upside risks to the 5 per cent inflation target remain, it believes that the risks are lower than envisaged before. The increase in area under kharif production could have persuaded it that increase in food supplies will help moderate food inflation in the coming months, easing food inflation further. It seems to have discounted the volatility in the food index caused by items such as onions, tomatoes and vegetables.   

 

Concurring with the Citi’s observation, another foreign financial services group Normura said the rate cut was justified not on the basis of an inflation undershoot (the RBI still sees March 2017 inflation at 5% with upside risks), but by tweaking the frame work. In fact, there has been a dilution of the tenets of the flexible inflation targeting framework under the new RBI (Dr. Patel) compared with the old RBI (Dr. Raghuram Rajan), says Nomura.

  

Religare, a domestic financial services unit said that even as the RBI cut the repo rate by 25bps, the cut was shrouded by a cautious commentary over the future inflation trajectory. Importantly, the RBI changed its stance on the neutral real rate and the timeframe for achieving the 4% inflation target, creating room for monetary easing.

Second, the real interest rate band of 1.5 to 2 per cent that the previous RBI governor, Raghuram Rajan had talked about has now been lowered to 1.25 per cent. With inflation at 5 per cent and the repo rate now at 6.25 per cent there is currently no space to cut rates further unless inflation surprises further on the downside. But the lowering of the real interest rate band is surprising and RBI doesn't seem to have elaborated on why it has lowered it except saying that it changes over time.

Third, the RBI has been careful enough not to give a specific timeline to achieve the 4 per cent inflation target. This move could be construed to mean that if inflation does indeed moderate further, it opens up space for the central bank to cut rates further.

Taking a real rate of 1.25 per cent, an inflation rate of 4 per cent, it corresponds to a repo rate of 5.25 per cent in the medium term. This suggests that a 100 basis point interest rate cut is likely if inflation moderates to around 4 per cent.

Fourth, the repeated emphasis on growth suggests that concerns over growth may have weighed heavily on the minds of the MPC members. RBI has retained its forecast for Gross Value Added (GVA) for 2016 at 7.6 per cent.

On the banking side also, there seems to be a shift in ways to deal with stressed assets. The emphasis was on being pragmatic to use creative ways for resolving bad loans. The decision to cut policy rates could be seen in conjunction with the tweaks to certain guidelines to address the NPA issue. This does signal a marked shift in the RBI’s approach under the new governor. 

Patel stressed on the need for ‘pragmatism’ along with ‘firmness’. The Statement on Developmental and Regulatory Policies also mentioned Large Exposure Framework. Also detailed guidelines for revamped asset classification norms under the S4A (Scheme for Sustainable Structuring of Stressed Assets) will be out by end October, Religare said.