RBI policy: Don’t halloo till you are out of the woods, says Indranil Pan

Aug 07 2014, 22:20 IST
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RBI Guv Raghuraman Rajan during a press conference announcing the monetary policy at RBI headquarters. PTI RBI Guv Raghuraman Rajan during a press conference announcing the monetary policy at RBI headquarters. PTI
SummaryGuv Raghuram Rajan-led RBI maintained its cautious approach and effectively moderated market expectations of imminent rate cuts.

Governor Raghuram Rajan-led RBI maintained its cautious approach and effectively moderated market expectations of imminent rate cuts. The RBI continued to aim at the 6% CPI inflation mark and will calibrate its policy stance based on the trajectory till January 2016. We maintain our call for repo rate remaining unchanged till end-CY2014. Further rate action will be predicated on the retail inflation transition to 6% in January 2016 from around 8% in January 2015.

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1. Rate cuts are not a given—focus on 6% retail inflation mark

Since the June monetary policy, markets had started to expect rate cuts as early as December. However, we maintain that rate cuts are unlikely by end-CY2014. In fact, the RBI’s reaction function will hinge on retail inflation transitioning to 6% by January 2016, which would require a structural shift in inflation dynamics. The key risks for the RBI to lower policy rates would be: (1) meaningful and sustained reduction in food prices, (2) qualitative and quantitative correction of fiscal imbalances, (3) supply-side correction to accommodate higher aggregate demand without inflationary pressures and (4) global events like geopolitical risks, commodity prices and other global central banks’ action.

2. Overall risks to inflation are ’more balanced than in June’

The RBI noted that the path to 8% by January 2015 was now more balanced than in the June policy, with a part being ascribed to the downward inflation trajectory due to steady deceleration in core CPI inflation. However, it noted some upside risks to inflation in the medium term (or the glide to 6% by January 2016), including the buoyancy in consumer and business sentiments that can also lead to aggregate demand picking up. The RBI needs to remain guarded against risks of a narrowing output gap, which can affect the growth-inflation dynamics. We believe that the RBI will probably be more comfortable to ease policy stance only after it anticipates that any monetary accommodation will not move inflation away from the glide path of 6% by January 2016.

3. SLR cut in line with requirement of liquidity coverage ratio (LCR) under Basel III

With the underlying fiscal consolidation in place and to signal an overall move towards reduced preemption of funds by the government sector, the SLR requirement was reduced to 22% of NDTL. Keeping in line with the Urjit Patel committee report recommendation that SLR should be reduced to a level compatible with LCR requirements

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