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  • 6 things to know about the first RBI policy under Urjit Patel

    It was the new RBI governor’s first monetary policy review. And it involved a 0.25% cut in benchmark interest rates. Naturally, markets and companies rejoiced the cut in interest rates—it makes borrowing cheaper and easier.

    We went through the policy statement and documents to understand why the RBI committee decided to cut rates.

Here’s what we found:

  • Inflation:

    Price rise is one of the biggest factors that the RBI takes into consideration. And it has also been the most troubling point. In August, however, retail inflation fell to a 5-month low of 5.05% after remaining stubbornly high at the 6% levels. This was because food inflation—the actual sticky problem—fell between July and August. This gave the RBI headroom to cut interest rates.

  • Monsoon:

    However, the RBI does not just look at past data. It looks at what lies ahead. Monsoon is one of the factors that decide inflation in India. 85% of the country received normal-to-excess rainfall this season. Because of this, farmers sowed more Kharif crops this year. As a result, the outlook for agricultural activity has brightened considerably, the RBI governor said in his monetary policy speech. This means the risk of high food inflation is lower.

  • Other risks:

    The GST and the effects of the 7th Pay Commission are the other two factors that could push inflation higher. However, the RBI notes that impact of the GST is likely to be limited. It’s expected to affect only 50% of the goods measured by the Consumer Price Index (CPI)—the key yardstick of retail inflation. Plus, it’s only expected to last for 12-18 months, according to the policy document. This means the RBI envisages risks to be lower than earlier—another reason for the cut in interest rates.

  • Growth:

    While inflation seems to be moderating, growth too seems to be cooling down. The productivity of Indian industries fell in the second quarter of FY2016-17. In the previous quarter too, growth in productivity slowed down. The manufacturing sector is the most affected. Of course, the services sector is seeing higher growth. That said, the poor growth makes the case for a marginal cut in interest rates.

  • Crude oil price:

    India imports most of its fuel. As a result, the price of oil in the international market can play a big role in deciding inflation in India. After all, any increase in oil prices in India would lead to a rise in all other prices. The RBI has considered a rise in oil price a threat. However, the latest policy points out that the threat is lower. Even though the oil producing countries talked about a cut in production, there has been minimal impact on prices. This too makes the case for a cut in interest rates.

  • Outlook:

    The RBI is positive about food inflation—that increase in food production and an improvement in the way food is distributed can help lower food inflation. It also expects that banks now have the bandwidth to cut interest rates too. “The momentum of growth is expected to quicken with a normal monsoon raising agricultural growth and rural demand, as well as by the stimulus to the urban consumption spending from the pay commission’s award,” the RBI policy statement said. That said, the RBI officially stopped short of hinting at another rate cut in the future. However, M.D. Patra (executive director at the RBI and a monetary policy committee member) hinted that policy interest rates could ease further.

    • The story behind the RBI’s October rate cut : Read more

    • How the Monetary Policy Committee (MPC) changes the policy game : Read more

  • $372 billion

    Another key risk is a shock from outside India. These affect India’s trade, current account deficit, and the rupee’s value. The RBI expects India’s trade and current account deficit to be lower in the July-September quarter thanks to falling imports. The RBI has also managed to increase its foreign exchange reserves to an all-time high of $372 billion. This means the RBI is building its arsenal to safeguard the rupee from risks like Britain’s exit from Europe.