RBI’s decision to hold interest rates reveals rift with Centre

MPC declined Finance Ministry invite; CEA counters central bank’s inflation view

The decision by the Reserve Bank of India (RBI) to leave its policy repo rate unchanged on Wednesday, shrugging off a sharp deceleration in April retail inflation, brought to the fore clear signs that the Centre and the central bank are not seeing eye-to-eye on interest rates.

Addressing the customary post-monetary policy press conference, RBI Governor Urjit Patel informed the media that the members of the Monetary Policy Committee (MPC) had declined an invitation to meet with Finance Ministry officials — a meeting that was scheduled to be held ahead of the monetary policy review.

“The meeting did not take place. All the MPC members declined the request of the finance ministry for that meeting,” Mr. Patel said when asked whether such meetings could undermine the central bank’s autonomy and hurt the credibility of the MPC.

For the first time since the six-member MPC was formed to decide on rates, the rate decision was not unanimous as one of the members, Ravindra H. Dholakia, dissented. However, the RBI did not specify whether Mr. Dholakia was in favour of cutting or raising rates.

Views on inflation

Tension had been brewing between the central bank and the government for some time over several issues, but the most important disagreement was RBI’s views on inflation. RBI had changed its policy stance from accommodative to neutral due to inflation concerns in February, which surprised many.

RBI, however, on Wednesday lowered its inflation projection to the 2-3.5% range for the first half of the current financial year and 3.5-4.5% in the second half of the current financial year.

At the same time, whether the unusually low momentum in the reading for April would endure was something that needed to be assessed, the RBI said. The MPC highlighted the risk of ‘premature action’ at this stage and thought it would be wise to remain watchful of the incoming data, thus avoiding disruptive policy reversals at a later stage.

Retail inflation in April had dropped below 3%. The projection for growth was revised 10 bps downwards to 7.3% for the current financial year.

Centre counters

The Centre was quick in its rebuttal. Chief economic adviser Arvind Subramanian issued a statement post the policy announcement, saying RBI’s inflation forecast errors had been large and systematically one-sided in over stating inflation.

“I think there is a plausible alternative macro-economic arrangement,” Mr. Subramanian said. “In this view, not just the headline inflation has been running well below the target and so far in advance, but core (which does not include transitory elements) inflation has also declined sharply.” he said, adding that inflation outlook had been rendered benign by an appreciating exchange rate, a good monsoon, and capping of oil prices by structural shifts.

However, some economists do not see a rate cut in the near future. “Rate cut not a done deal!,” said HDFC Bank chief economist Abheek Barua. “It could also be the case that the RBI is reluctant to change its stance too-fast too-soon. Therefore, if the monthly inflation momentum moves closer to the lower end of the RBI’s projected path, then a rate cut cannot be ruled out,” he said.

Nomura economists said in a note that they currently expected the RBI to leave rates unchanged through March 2018, which would then be followed by a cumulative rate increases of 50 bps starting April 2018. “Our forecasts are currently under review,” the note said.

Mr. Patel, who has been critical of farm loan waivers announced by some States, again cited the risk of fiscal slippages that could entail inflationary spillovers. The RBI took some steps to boost credit demand. The risk weight and standard asset provision requirement for home loans were pared.

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