The RBI Monetary Policy Committee (MPC) presented the fourth bi-monthly monetary policy statement for 2018-19 today. By now you are aware that policy rates have been maintained, that is, repo rate remains at 6.5 percent. The bigger takeaway is that the MPC has changed stance from ‘neutral’ to ‘calibrated tightening’. The normal implication of the term neutral is that the central bank would not tinker with policy rates, unless there is something exceptional, requiring policy rate to be hiked or reduced. However, even within the neutral stance, the MPC cut the policy rate in August 2017 and hiked in June and August 2018. Whether the situation was exceptional during these times is debatable.
That the stance has been changed to ‘calibrated tightening’ in a way lends clarity on RBI’s approach to policy rate formulation, that is, given the challenges of a weak rupee, high crude oil prices, high current account deficit, the inclination would be towards a rate hike. However, on the other hand, it has opened up the window for guess-work as the inflation projection has been reduced. Inflation projection for the second half of FY19, that is, October 2018 to March 2019 has been revised downward to 3.9 percent – 4.5 percent from 4.8 percent projected in the August Review. For Q1 of FY20, that is, April to June 2019, it is revised downward to 4.8 percent from 5 percent of August. Hence, effectively, market will interpret data prints like inflation and communication from the RBI in various forums to gauge the approach to rate formulation going forward.
The market movement has been a little favourable; government bond yields have eased somewhat after the policy announcement. The reason for the favourable market movement is that since the RBI had hiked rates twice even within the neutral rate stance, and sounding alarmist on inflation, it was factored in to an extent. It is also an indication of immediate relief that at least for today, the apprehension of a rate hike is off the table.
In the run-up to today’s policy review, yield levels had run up significantly as a rate hike was almost certainly priced in, going by consensus estimates. It is debatable whether an interest rate defence of the currency would work as we had seen in 2013. The RBI hiked rates steeply in July 2013 but foreign portfolio flows did not come in, till the special scheme for NRIs was launched in September 2013. However, given the all-time weak rupee and high crude prices, market apprehended a rate hike today from the RBI.