The Reserve Bank of India’s policy guidance on Tuesday will be key as most experts foresee a pause in the interest rate action by the central bank.
Of immediate concern is the rise in the June CPI inflation, lifted by higher food prices, seasonal influence in the housing index and one-off adjustment in service taxes, said Radhika Rao, Economist, DBS Group.
While inflation is still well-below the central bank’s January 2016 target of 6 per cent, worries are that the strong start to the monsoon rains in June might peter out into August, she added.
Since January, the central bank has cut policy rate three times, by 25 basis points each time, and brought it down to 7.25 per cent. The last rate cut was announced on June 2 after two back-to-back out-of-policy rate cuts in January and March.
A basis point is one-hundredth of a percentage point.
Though research firm Moody’s Analytics anticipates a likely cut in the benchmark rate by 0.25 per cent on Tuesday, most experts do not expect any cut.
According to a Deutsche Bank report, “While a pause on August 4 is widely expected, the RBI’s guidance will be interesting, given the uncertain local and global growth and inflation environment. We expect the RBI to maintain a neutral stance in its policy review, while highlighting the potential upside risks from an uncertain food price outlook.”
It added that the food price outlook is not encouraging at the moment.
“Typically, pressure on food prices persists till August and then from September onwards there is a natural course correction which sets in motion. We expect the same trend to play out this year, but the question is whether food price spikes will overwhelm once again in July as was the case last year or will the rise be contained, thanks to the government’s various administrative measures that have been put in place since last year,” the report said.
“With regard to liquidity measures, the RBI recently demonstrated its discomfort with easy liquidity conditions. This keeps the door open for operational changes in term repo limits, alongside better clarity on other tools that could be used to mop excess liquidity (reverse repos, MSS, cash management bills). Policymakers will need to balance liquidity sterilisation in a manner that does not deviate from its central monetary policy stance,” Rao said. Further, the US Fed, in particular, was non-committal at its recent FOMC meet but the balanced tone on employment and inflation trends keeps hike expectations supported.
“Notably, the RBI rate review in September is scheduled a fortnight after the US FOMC meeting. Any renewed indication of normalisation in rates would limit the RBI’s room to lower rates,” Rao added.
In addition, the debate on the RBI Governor’s current veto power in the monetary policy committee (MPC) continues given the changes in the draft India Financial Code that limits the Governor’s role.
Some say the controversial changes in the code that suggest that powers vest with the Union government to appoint four members of the seven-member MPC of the central bank, erode powers and autonomy of the RBI. On the other hand, some see it as a move to make the committee more transparent and institutional even though the Finance Ministry has tried hard to distance itself from the controversy.
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