The RBI Monetary Policy Committee's decision to not cut rates in the latest policy review has been met with myriad interpretations and conclusions. One interpretation is that now the MPC is definitely less accommodative than it was and the market needs to recalibrate rate cut expectations. A second interpretation is that the rate cut has just been “paused” for one meeting and status quo ante continues as far as the Reserve Bank of India's and the MPC’s dovishness is concerned. A third interpretation, very much like the second, holds that the RBI and the MPC remain accommodative and are preserving the firepower for a tactical cut in February when a high borrowing will hit the market and the RBI can blunt yields a bit by cutting then.
The MPC statement seems to indicate that the second interpretation holds: Sample this: The MPC recognises that there is
monetary policy space for future action. However, given the evolving growth-inflation dynamics, the MPC felt it appropriate to take a pause at this juncture. The MPC decided to continue its accommodative stance as long as it is necessary to revive growth. There is no ambiguity here in the MPC’s intent to go on cutting. The governor too was at pains to explain that it would be worth using the cuts at a time when the economy derives optimum benefit and that is the only reason for the pause. Also read: RBI Monetary Policy: Central bank keeps repo rate unchanged at 5.15%
That said, it is important to hear out what the 15 basis point rise in bond yields on Thursday is telling us. This jump in yields clearly shows that a significant part of the market believes the MPC’s stance has changed to at least "less accommodative" if not almost "bordering on neutral".
UTI Mutual Fund's fixed income head, Amandeep Chopra, went to the extent of saying the terminal repo rate in this cycle may be 5.15 percent i.e. no further rate cuts may be expected. Others, like Rajiv Anand, the executive director of Axis Bank, says that while there may be cuts in 2020, the hurdle rate has gone up. That is, the MPC will cut only if it is convinced that inflation won't fly off the handle. This in itself is a significant departure from previous policies where the governor repeatedly said he would do "whatever it takes" to revive growth.
Also read: RBI cuts FY20 GDP growth forecast sharply to 5% from 6.1% projected earlier
Economists like Sajjid Chinoy are expecting inflation to rise to 5.5 percent in November and go even higher in December. As the governor said, core inflation too may spike a bit due to the rise in telephone tariffs. But Chinoy and other economists expected the MPC to look through these food inflation spikes as transient and cut rates.
However, the fact that the MPC members unanimously voted for a pause shows that economists and markets underestimated the MPC’s commitment to its given mandate. Many expected the MPC statement to say that the committee will interpret its mandate as 4 percent CPI, +/- 2 percent i.e., the MPC will tolerate CPI moving in a 2-6 percent band.
The pause in the latest policy and the reasons advanced show that the MPC is not going to be this flexible. To quote from the statement, the MPC does expect inflation "to rise in the near term but moderate below target by Q2 2020-21". The MPC now says it would want "clarity" on whether inflation is actually moderating before it acts.
In fact, the governor’s growth-related comments are consistent with this cautious approach to inflation. Although the RBI has cut growth forecast to 5 percent, the governor pointed to several green shoots. He points out that November PMI (Purchasing Manager's Index) both manufacturing and services rose sharply from October lows. Also, sample this statement from his opening remarks: Unaudited results of 1,539 listed private manufacturing companies suggest that funds mobilised by these corporates during H1:2019-20, including possibly the saving on account of the corporate income tax cut effected in September, were mainly used for fixed assets formation and deleveraging (reduced borrowing). These companies were investing in financial instruments such as investment and loans and advances during the last couple of years in the face of subdued demand.
This shift to investment in fixed assets under the head ‘capital work in progress’ in H1:2019-20 appears to be broad-based and even after excluding a few large companies from the sample, the preference for fixed assets is noticeable.
Furthermore, pipeline projects sanctioned by banks/financial institutions in the preceding years envisage an expansion in capex spending for the year 2019-20. While these developments are still tentative, they would need to be carefully monitored with incoming data to look out for a durable revival in the capex cycle".
Also read: RBI Monetary Policy: Why the central bank chose not to cut rates
All these elaborate arguments give the impression that people like Rajiv Anand are right: the hurdle rate for the next rate cut has certainly gone up. And the fact that ALL the MPC members voted for a pause shows that all these arguments plus the sharp rise in inflation expectations have diluted the “accommodative-ness” of the MPC. It is not status –quo ante with expected rate cuts merely postponed. There is a good case to believe that the MPC has recalibrated the number of cuts and the terminal rate in its own head. How accurate this assessment is, we will know when the minutes of the meeting are published.Maybe the minutes will surprise and the governor may yet manoeuvre a cut in the February policy. But it has to be said that with this policy, Shaktikanta Das is much less a former finance secretary and much more a central banker. For the same reason, it appears he is unlikely to allow the government to use the central bank’s balance sheet for an Indian TARP (troubled asset relief programme). His playful evasion of that question was telling.