Unlike most central banks that move in conventional cycles-either tightening or easing-the Reserve Bank of India need not, thanks to its role as a full-service central bank.
When the role of the monetary policy maker is also that of a financial markets regulator and supervisor of the players in it, balacing the interests of consumers as well, interest rate and liquidity decisions are often swayed by the priority of maintaining financial stability.
As the Monetary Policy Committee meets with three new external members, the more dominant question is not interest rate reduction, or monetary stance, but liquidity and deposits crunch that banks face.
The consensus is the MPC will go for a status quo on interest rate, and the possibility of shifting its stance to ‘neutral’ from ‘withdrawal of accommodation.’
It’s a triple challenge-uncertainty caused by geopolitical developments in the Middle East, the farm output impact on inflation trajectory, and the softening of growth impulses. Which one will weigh the most?
While this meeting is set amidst the reduction of policy rates by the Federal Reserve by 50 basis points, the RBI’s declared stance is that it goes by the mantra ‘what is good and needed for the Indian economy’ rather than to be dictated by actions elsewhere. A basis point is 0.01 percentage point.
Outcome of geopolitical conflicts is what even those driving it don’t have control over. The Russia-Ukraine conflict that started in 2022 shows what’s probably in store in the Middle East flare-up involving Israel and the Arabs. The first-level reaction-oil prices shot up more than 8% in a week. Be comforted that RBI’s assumption of crude oil prices for its forecast is $85 a barrel compared to Friday’s $78 a barrel.
Inflation, mostly driven by food prices which has 46% weighting in the Consumer Price Index, is more uncertain than geopolitics given its exposure to shocks from truckers’ strike to excess rainfall in a region. But the bountiful monsoon has given hopes of it softening and taking it towards the 4% target, from an average of 6.6% for five and a half years. The comfort factor here is that core inflation-stripping out food and fuel-has averaged 3.5% this year reflecting the success of inflation targeting.
India’s flexible inflation targeting mandates maintaining ‘price stability, while keeping in mind the objective of growth.’ That brings in the latest macroeconomic numbers which though robust are showing signs of slowing.
“The latest GDP, PMI Manufacturing, motor sales, cement production, bank credit, corporate tax collections, GST revenue growth and goods exports, have been softer than before,” says Pranjul Bhandari, economist at HSBC.
While these may be core of the MPC debate, the financial system is hobbled by deposits, and liquidity which are more powerful than the policy repo rate, the rate at which RBI lends banks. It is at 6.5%.
Core liquidity which measures the system, plus the government cash balances is at ₹4.5 lakh crore, up from ₹2.3 lakh crore in March. Expectation of a change in stance and flows due to JP Morgan Index inclusion has already pushed down yields by about 30 basis points.
But the deposit scenario is not half encouraging where the financial stability plays a role as well. After a clampdown on unsecured loans and lending to non-banking finance companies, the regulator is still agitated. The latest diktat on gold loans is an example.
Pure macroeconomic conditions-inflation and growth outlook-may present a case for a reduction in interest rates.
“The RBI doesn’t gain from waiting any longer,” says HSBC’s Bhandari.
If financial stability weighs more than the macroeconomy, the choice may be to wait.
