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The RBI faces a tough call on setting policy rates given the inflation and liquidity concerns
The Reserve Bank of India’s Monetary Policy Committee (MPC) is set to meet for three days, October 3-5, to decide its policy stance. With the U.S. Federal Reserve now firmly set on its policy normalisation path and having, just last week, raised interest rates by 25 basis points, the RBI would normally be expected to increase benchmark borrowing costs in India in a bid to prevent heightened outflows of rate arbitrage seeking portfolio capital. Additionally, the rupee’s depreciation of more than 12% against the dollar in 2018, combined with crude oil’s continuing upward march — Brent futures closed at $82.73 a barrel on Friday — raise the risk of India importing inflation from the higher price for its overseas energy purchases, making the argument for a rate hike even more compelling. After all, given its unequivocal inflation-targeting mandate, the MPC would be well justified in keeping its sights firmly trained on the retail inflation trend and household expectations for future price gains. Also, while headline CPI inflation eased appreciably in August to 3.69%, core retail price gains, which exclude the food and fuel and light groups, was still running 190 basis points higher at 5.59%. It was precisely this core element that Deputy Governor Viral Acharya cited in his statement at the MPC’s August meeting when he said: “Underlying inflation as reflected in ‘ex food fuel’ segment, especially in petrol and diesel, transportation (including fares), education fees, health services and clothing persists, and does not augur well for headline inflation going forward.” Food prices that, surprisingly, have remained benign, helping slow overall CPI inflation, could also start hardening once the impact of the higher payout on the minimum support price for kharif crops kicks in. However, recent developments in the domestic financial system that have triggered concerns about the health of the credit market are likely to roil the MPC’s rate-setting calculus. First, on September 23, the RBI issued a one-sentence press release that along with the capital markets regulator it was “closely monitoring” developments in the financial markets and they were ready to take “appropriate action”. Four days later, on September 27, it announced a relaxation in the Liquidity Coverage Ratio for banks in a move to soothe concerns about adequacy of liquidity. Read together, the message from the banking regulator appears to be that it is keen to ward off any risks to the availability and cost of short-term credit from any unforeseen financial market volatility. The tweak to the LCR norms is expected to free up close to Rs. 2.5 lakh crore in additional liquidity, with half of it, or Rs. 1.25 lakh crore, becoming available to the banking system at the more affordable repo rate of 6.5%. It is this concern about the financial markets that will make the MPC’s task just a little trickier.
Source : https://www.thehindu.com/todays-paper/tp-opinion/tricky-call-ahead/article25091726.ece
