RBI’s Monetary Policy: A Review
On September 30, the Reserve Bank of India (RBI) kept key rates (Repo Rate, Cash Reserve Ratio, Statutory Liquidity Ratio, and Reverse Repo Rate) unchanged in its fourth bi-monthly review of monetary policy. This was largely expected from the RBI Governor Raghuram Rajan, who has previously reiterated at several forums that he is not influenced by “positive sentiment” and that his primary objective is to curb inflation in the long run. Dr. Rajan has raised policy rates three times since his tenure began in September 2013.
RBI’s near-term objective is to reduce inflation to 8 percent by January 2015 and to 6 percent by January 2016. Recent inflation data suggests the RBI is on track to achieve this; in September 2014, it was reported that consumer inflation had fallen to a three-year low of 6.46 percent and that wholesale inflation had eased to a five-year low of 2.38 percent. However, a weak monsoon with a deficit in rainfall could have an adverse impact on winter crops and exert inflationary pressure. Along with food price shocks, the RBI added that geopolitical developments could become the major obstacles to achieving inflation goals. As a result, Rajan has conceded that the 2015 target would be more easily achieved than the 2016 goal of 6 percent. However, analysts were unanimous in their view that RBI is unlikely to cut its key rates in the remaining period of this fiscal year.
Meanwhile, media reports suggest that the finance ministry has begun discussions with the RBI for the creation of a Monetary Policy Committee (MPC) to modernize the process of preparing India’s monetary policy by including representatives from the government as well as independent experts. These follow recommendations made by the Urjit Patel-led Expert Committee to Revise and Strengthen Monetary Policy Framework, as well as the BN Srikrishna-headed Financial Sector Legislative Reforms Commission, and was also discussed in the latest budget presented by the new government on July 10. Currently, the RBI governor is the sole authority to decide monetary policy, which primarily targets inflation. If the proposal is accepted, monetary policy would be decided by the MPC through a vote and the RBI would simply implement decisions taken. The government hopes to complete the necessary framework for the creation of an MPC by February 2015.
On economic growth, the RBI noted the recent mood of cautious optimism and predicted the economy's growth projections for the current fiscal year at 5.5 percent. Rajan asserted that clearing pending projects and reviving investment activity is the key to further economic growth. Two recent developments indicate there has been an uptick in economic recovery. On September 26, Standard & Poor revised its outlook for India’s sovereign "BBB-minus" rating from “negative” to “stable," saying that the country's government mandate and improved political setting offered a conducive environment for reforms. Second, in the hopes of accruing higher tax revenues from an economic revival and from the sale of government assets, Finance Minister Arun Jaitley cut the government's borrowing target for the FY15 by over $1 billion.
The current account deficit which was at 1.7 percent of GDP for Q1 of 2014-15 would remain contained in Q2 primarily due to the improvement in the trade balance caused by a fall in gold imports. However, reserves denominated in US dollars have moderated, largely because of the growing strength of the US dollar. Ahead of the RBI’s monetary policy review on September 30, the government stated it was confident of achieving its target of keeping fiscal deficit at 4.1 percent of GDP for the current financial year.
In the run-up to the General Elections 2014, media speculation suggested that Dr. Rajan would be eased out of his position as the RBI Governor once the pro-growth Modi government came to power because of Dr. Rajan's decision to prioritise inflation over growth. However, in the last four months, the Finance Ministry and RBI seem to be on the same page as far as macro-economic policy is concerned, with the Finance Minister Arun Jaitley publicly supporting RBI’s monetary policy. In an October 16 address to students of the Indian School of Business in Hyderabad, Rajan said: "The truth is that the government and the RBI enjoy a free, frank and cordial relationship. We discuss many things and we find and do what is in the best interest of the country.”