On the face of it, the six-member monetary policy committee of the Reserve Bank of India (RBI) did what most observers expected it to do — defer a policy rate increase. The markets responded accordingly, barely moving after the policy was announced. A few banking stocks were affected, possibly because the RBI also announced its decision to “harmonise” the methodology for determining benchmark rates by linking the base rate to the marginal cost of funds-based lending rate (MCLR). While the move is aimed at improving monetary policy transmission, it might affect bank margins at a time when base rates are facing some upward pressure. There was also some relief provided to medium, small and micro enterprises, which are struggling to pay their dues to banks in the wake of the disruption brought on by the goods and services tax. However, beyond these announcements, there was a lot of meaning in the fine print of what the RBI stated in the policy document and later at the post-policy press conference.
For one, the RBI has dialled back, albeit slightly, its projections for gross value added for the current financial year to 6.6 per cent from its recent bi-monthly policy assessments. However, this level of GVA will still yield better gross domestic product growth than the estimates of the Central Statistics Office. The bigger concern continues to be inflation. Retail inflation increased for the sixth consecutive month in December, thanks largely to an unfavourable base effect. But even going forward, household inflation expectations, measured by the RBI’s survey of households, remain elevated for both the three-month and one-year ahead horizons. The problem is, there are a whole host of factors that could spike inflation. Apart from a possible crude oil price increase, RBI Governor Urjit Patel specifically talked about the threat from the recent increase in Customs duties as well as the potential increase in minimum support prices for different crops. On the surge in bond yields, Mr Patel pointed at the fiscal slippage — not just for this year but also for the next financial year as well as in the medium term — at a time when there are growing demands on financial capital because of a nascent recovery.
The governor did not limit his displeasure just to the fiscal slippage. Answering a question on what was holding back the investment to GDP ratio in the economy, he pointed to the multiple taxes that were being levied on capital in India, including corporate tax, dividend distribution tax, securities transaction tax and capital gains tax. It is obvious that the RBI is unhappy not only with the fiscal slippage that has already been announced but also with the potential of further slippages via higher MSPs. The RBI has clearly signalled that its primary concern remains keeping prices under control. As such, even though the RBI did not change its stance from “neutral”, it has alerted the government that fiscal irresponsibility will extract an appropriate response.