RBI’s surprise move met with approval
In a surprise move on Wednesday, the Reserve Bank of India (RBI) elected to leave its policy interest rate unchanged, defying broad expectations that the bank would raise rates for the third time in a row in response to rising inflation.
According to a report on Livemint, markets responded positively to the unexpected announcement.
“The rate pause came as a pleasant surprise to the financial markets. The rupee and stocks rose and bond yields fell sharply as investors rushed to buy local assets, hoping for the comfort from a benign interest rate environment, which will, in turn, act as a catalyst to the business growth of companies by lowering their cost of money. Bond prices and yields move in opposite directions.”
“The unexpected rate pause cheered industry lobby groups, which said this was much needed to prop up the economy… Keeping interest rates in check will also support stocks at a time when the government needs to sell stakes in state-controlled companies to help achieve a fiscal deficit of 4.8%.”
Quoting RBI governor Raghuram Rajan, the article also explains the rationale behind his surprising decision.
“’The policy decision is a close one,’ said Rajan. He admitted that the current level of inflation is still high and that RBI had refrained from raising the rate considering both the ‘weak state of the economy’ and the fact that the rise in inflation, driven by food prices, is likely to be temporary. ‘There is merit in waiting for more data to reduce uncertainty.’”
An article in the Economic Times also welcomed the move, arguing that though inflation rose significantly in November, a third increase in interest rates would do little to address the underlying structural issues pushing inflation.
“An increase in interest rates could spell more trouble for the economy, given the slowdown in growth and contraction in industrial production…A monetary squeeze has little impact on food prices. Instead, the government should implement structural reforms and contain the fiscal deficit, a key driver of inflation.”
“A big factor driving food inflation is the increase in rural wages in real terms. This has led to higher demand for superior foods: vegetables, pulses, eggs, meat, fish and poultry. Demand has outpaced the increase in production, leading to an upward pressure on prices. Increasing food supplies is the answer. But the management of food stocks is directly under the government's control.”
A second piece in the Economic Times emphasized the role of the U.S. Federal Reserve’s expected taper in the coming days.
“Now, the big worry is from the US. The US Fed is expected to issue statement later today on QE tapering; and there is a probability that it could announce a taper…Had RBI gone for a rate hike at its policy meet today, the market probably would not have reacted very negatively, as experts had said that the investors had already factored in that kind of a hike. But as a pleasant surprise for the market, the RBI went for a no-change in the policy rate, giving a boost to the market in the wake of the prevailing uncertainty over America's QE programme.”
Writing in the Business Standard, Malini Bhupta took a different approach to the news, questioning whether the RBI’s unexpected move could damage its future credibility.
“After a sharp uptick in headline inflation for November, a rate hike was a given. But Reserve Bank Governor Raghuram Rajan decided not to react to the “noise” and to instead wait for more credible data. Rajan has only staved off the inevitable to a later date, thereby risking the central bank’s credibility, as the risks to the currency are not over and the trend in food prices does not indicate any softening. While there is nothing to suggest his stance has turned dovish, the market is concerned about the central bank’s inaction.”
“November might have seen an “unseasonal” spike in vegetable prices but there is no denying that the increase in food prices have averaged at 10.6 per cent annually over the last seven years and might not cool meaningfully soon. The message RBI has sent on Wednesday is it will act only when risks to the currency materialise, which would depend on the US’ decision to taper its stimulus programme.”
Another article in the Business Standard notes that few CEOs would have predicted the RBI’s move.
“Just a day before the policy announcement, almost all CEOs had predicted the high inflation would lead to RBI Governor Raghuram Rajan announcing a rise of up to 50 basis points in the policy rate. But with Rajan maintaining status quo on rates, they say clearly, the governor is focusing on growth, after two consecutive rises in rates dampened investments.”
“Rajeev Talwar, executive director, DLF, said the RBI move was the first sign of recovery. ‘If the government releases enough food stock in markets, food inflation will come down, and we can expect a better response from the RBI governor. He has done extremely well to withstand any compulsion to hike rates,’ he added.”
The article also touched on the impact the move was likely to have on long-stalled infrastructure projects.
“Owing to the high cost of funds, many infrastructure projects are stalled, and very few companies are starting new ones. ‘While we understand RBI has to be primarily concerned with price stability and fiscal policy has to complement monetary policy in getting the economy back on track, a symbolic cut would have helped the corporate sector. Corporate investments and capital expenditure for the future may at least have been given a strong positive signal; interest-sensitive sectors could have added to growth,’ said Yogesh Agarwal, managing director of Avantha Group’s Ballarpur Industries Ltd.”
The Hindu Business Line published a piece lauding the RBI’s surprise move, touting it as “wise to wait.”
The Reserve Bank of India (RBI) has wisely refrained from raising interest rates or reserve requirements on banks in its mid-quarter policy review….The RBI’s action shouldn’t be viewed as an intention to surprise — even if Raghuram Rajan has managed to do this unfailingly since becoming Governor — as much as the need to be slightly ahead of the curve.”
“The RBI has rightly decided against an “overly reactive policy action”, and to wait for the “next round of data releases” before embarking on any further monetary tightening. It is incorrect to see this approach as being ‘soft’ on inflation. Instead, it is realistic, given that India is poised for a bumper agricultural harvest this year, thanks to a very good monsoon. Its effects have not been felt fully on prices only because of delayed crop arrivals from extended rains. No great harm would befall the economy from waiting till at least mid-January.”