At the fourth bi-monthly monetary policy review for 2016/17 in Mumbai tomorrow (October 4), all eyes would be on the six-member monetary policy committee (MPC) that would for the first time decide the future course of interest rates in the economy. This is a clear departure from the earlier practice of RBI governor taking the final call. And hence the suspense.
The MPC is empowered to fix the repo rate or the policy rate, which is at 6.5 per cent from April this year, to contain inflation within a target of 4 per cent (+/-2 per cent). So, there is a big band of 2 per cent to 6 per cent. There is a view in the market that the three members (of repute) appointed by the government would push for a 25 basis points rate cut as the mandate of the new committee is to maintain price stability and keep in mind growth objectives. In the past two years, the new government's biggest concern was about growth with some ministers attacking former RBI governor Raghuram Rajan for not doing enough on easing the interest rates.
This is also Urjit Patel's first monetary policy review as a RBI governor, though as a deputy governor (in charge of monetary policy), Patel was part of all the deliberations for over three years. That indicates that he was in sync with Rajan's policy of taming inflation before rates could go down further. In fact, Patel authored the report on inflation targeting, which recommended the 4 per cent target with RBI accountability in case the target is not met for three quarters. How Governor Patel reacts remains to be seen.
Currently, the CPI or retail inflation is still not in the comfort zone of the RBI. At 5.05 per cent for August this year, the CPI is a tad above the 5 per cent level targeted by the RBI for 2017. In 2016, the CPI was below 5 per cent only once in March.
There are many who say inflation should be below 5 per cent on a sustainable basis. Going forward, the 7th pay commission hike would also fuel inflationary pressure. There are two new variables - bottoming out of commodity prices and possible rupee depreciation. The commodity prices have almost bottomed out and there are fears of prices moving up gradually, which would impact the inflation numbers. Similarly, the dollar deposit redemption is coming up, which would result in outflow of dollars and possible rupee depreciation against the US dollar. This event has the potential to ignite imported inflation through oil prices and other commodities.
Meanwhile, the wholesale price index (WPI), which was in the negative zone for a long time, has started its upward journey. The WPI generally shows up in the CPI with a lag effect. WPI ended at a two year high at 3.74 per cent for August.
While there are enough indications for a pause by the MPC this time around, but one should not ignore the new regime at RBI under Patel and also an MPC with half the members directly appointed by the government. There are already indications of a change in the thinking. Last week, Patel, who interacted with economists, downplayed the risk of inflation and instead talked about the growth.
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