RBI seen maintaining status quo in Raghuram Rajan’s last policy review

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Outgoing Reserve Bank of India (RBI) governor Raghuram Rajan will likely choose to leave policy rates unchanged on Tuesday, leaving it to his successor to decide on future rate cuts.

Out of 10 economists and bankers surveyed by Mint, nine expect RBI to keep the repo rate—the rate at which commercial banks borrow from the central bank—unchanged at 6.5% on Tuesday. The reverse repo rate would stay at 6% and the cash reserve ratio (CRR)—the portion of deposits that banks must hold with RBI—may also stay steady at 4%. Bank of America Merrill Lynch was the only one that expected the central bank to cut its repo rate by 25 basis points. A basis point is one-hundredth of a percentage point.

The quickening of inflation for three consecutive months has put the retail reading well above RBI’s March 2017 target of 5%, and reduced the odds for an interest rate cut significantly, analysts said.

Retail inflation rose to 5.77% in June, driven by a spike in vegetable prices, significantly above RBI’s stated target and uncomfortably close to the high end of the target inflation range of 2-6% mandated by the government.

Also see: Markets looking beyond Raghuram Rajan, August policy

“There is an outside chance that the RBI’s 5% target of inflation may not be met,” said Soumya Kanti Ghosh, chief economist at State Bank of India, the country’s largest lender.

The inflation trajectory is still fraught with uncertainties as many of the upside risks flagged by the central bank in the June policy are yet to play out, barring the monsoon.

Rainfall across India has so far been above the long-period average, which augurs well for farm output this year. This, coupled with astute food management, may pull down food price inflation.

However, wage hikes for government employees will likely increase consumption, putting pressure on inflation. Last week, the government decided to pay its employees seven months’ arrears at one go with their August salary.

While global crude oil prices are down 20% from their recent highs, the Bank of England’s move to restart its bond-buying programme could lead to asset prices across geographies flaring up.

The government’s retention of RBI’s 4% medium-term inflation target also puts paid to a pro-growth approach. The government on Friday notified the acceptance of this 4% target with an upper and lower tolerance threshold of 2 percentage points.

“What we would like to see is the RBI’s road map of achieving the 4% target. In my opinion, 4% is next to impossible,” said Ghosh. In the near term, inflation is already close to the upper limit.

Also see: When is a 4% inflation target really 4%?

According to Ghosh, now that the goods and services tax is almost through, it will likely push up consumer price inflation by at least 25 basis points.

The bimonthly policy review on Tuesday, the last of Rajan’s tenure, will be key as it will set the tone for the succeeding governor’s policy measures, market participants said.

On this front, analysts said Rajan is unlikely to change the policy stance and will leave the door open for his successor to cut rates if room emerges.

Some do feel this room will indeed emerge, given that inflation is expected to ease beyond September. “Our analysis is that because of monsoon and expected sharp increase in pulses output, inflation will fall off post September,” said A. Prasanna, chief economist at ICICI Securities Primary Dealership.

In the last policy, Rajan had pointed to the upside risks to inflation and at the same time said retail prices would cool beyond September.

Further, the central bank is expected to reiterate its statement of keeping liquidity in the banking system neutral, helping further transmission of past policy rate cuts on lending rates.

To be sure, some banks have passed on rate cuts by paring their marginal cost-based lending rate (MCLR), which was adopted in April. The process of transmission is still slow.

While RBI has cut the policy rate by a cumulative 150 basis points since 2015, SBI’s benchmark lending rate is now only 90 bps lower.

Tuesday’s policy would likely stick to the script of past statements. But even a status quo stance will leave policy flexibility to the next governor, who is yet to be named by the government.

Given that the process of interest-rate setting will be institutionalized by the formation of a monetary policy committee, Rajan’s final policy review could form the bedrock of the future monetary policy process. To that extent, Tuesday’s review would be crucial.