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  • Interest rate status quo: RBI chooses growth guard over inflation fighting

    Publish Date: October 05, 2018

    The Reserve Bank of India (RBI) on Friday left key interest rates unchanged, which came as a pleasant surprise. This spares corporates and retail borrowers any additional interest burden on their loans that may have arisen if the central bank had raised the rates. The stock markets heaved an initial sigh of relief, quickly narrowing losses from over 500 points to 350 points after the RBI policy statement was flashed. But selling again rose in the last house, with the Sensex down 850 points soon. The dollar, however, continued to trade strong against the rupee at over 74-levels. Let us try to understand why the RBI chose to stick to the current interest rates even though the markets expected a 25 bps rate hike.

    Not worried by noise

    The Monetary Policy Committee (MPC) says that its decision is consistent with the stance of calibrated tightening of monetary policy. It is in consonance with the aim of achieving the medium-term target for consumer price index (CPI) inflation of 4% within a band of +/− 2%, while supporting growth.

    Some key events in the run-up to the MPC decision are of importance for investors.

    • Since the previous MPC meeting in August 2018, global economic activity has remained resilient. This is despite ongoing trade tensions.
    • Among advanced economies (AEs), the United States (US) showed a sustained pace in the third quarter.
    • The Japanese economy has so far maintained the momentum of the previous quarter.
    • On the domestic front, India's real gross domestic product (GDP) growth surged to a nine-quarter-high of 8.2% in Q1.
    • The fourth advance estimates of agricultural production for 2017–18 released in August placed food grain production at a high of 284.8 million tonnes, 1.9% higher than the third advance estimates released in May 2018.
    • Industrial growth, measured by the index of industrial production (IIP), accelerated in June–July 2018 on a year-on-year (y-o-y) basis.
    • The August and September manufacturing purchasing managers’ index (PMI) remained in the expansion zone.
    • Retail inflation, measured by the y-o-y change in the CPI, fell from 4.9% in June to 3.7% in August.

    All in all, the RBI knows the situation. But it chose to pass the opportunity to tinker with interest rates for now. Many assumed the RBI would put on its inflation-warrior suit to combat inflationary pressures arising from high oil prices and a weakening rupee. But it turns out that the RBI is hawkish about growth.

    The MPC, however, shifted its policy stance to ‘calibrated tightening’ from ‘neutral’. As many as five of the six panel members voted to leave the rate unchanged.

    Also Read: The positive side of rupee depreciation

    Watching inflation but wanting growth

    The central bank seems to have decided not to react to the noise surrounding inflation. But it remains watchful of the situation.

    The RBI noted that global headwinds in the form of escalating trade tensions, volatile and rising oil prices, and tightening of global financial conditions pose substantial risks to the growth and inflation outlook. However, it decided to protect the Indian interests. A rise in interest rates can stymie the growth signals seen in the economy. Therefore, by not raising interest rates it has strengthened domestic macroeconomic fundamentals.

    Also read - To hike or not to hike: The RBI dilemma

    By retaining the repo rate at 6.5%, the RBI has fostered its growth agenda. The central bank is known for its inflation warrior status, of course. But being the protector of domestic growth is something RBI is very serious about. Its decision to let the interest rates remain, for the time being, shows this side of the central bank.

    The reversal of the low interest rate cycle and easy liquidity would put pressure on financial companies and ultimately the borrowers. For corporates, this would have serious implications for growth as interest costs would dent margins.

    For non-banks, the effect of an interest rate hike is larger. Given the liquidity crisis fears in NBFC circles, the RBI has given every financial and non-financial company some relief on the interest-rate front.

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