MPC may maintain status quo in its first meet

As the Reserve Bank of India (RBI) prepares itself for the first monetary policy review on October 4, under the new governor Urjit Patel and by the newly-formed monetary policy committee (MPC), economists seem to be divided on the outcome.

While a section believes that the falling inflation may give some room for the six-member MPC to reduce interest rates by 0.25% when Patel unveils his first policy as governor of the central bank, some others argue that it is going to maintain status quo. Some economists say that the food prices are erratic and the regulator needs to be certain about the trajectory of the inflation before it wields the knife. The softening in the soaring food prices have resulted in the fall of inflation from 6.1% in July to 5% in August.

Prajul Bhandari, chief economist at HSBC, said in a report, there are some good reasons why a rate cut could materialise in the upcoming October 4 meeting. The recent fall in food prices has been sharper than expected, and cutting rates sooner will keep the RBI a safe distance away from possible US Fed hikes. "Yet, our base case is for a rate cut in December." By December, two new inflation prints which are expected to be well below 5% will be available, giving the central bank enough of justification to inflict a cut. Moreover, given that the RBI was highlighting upside risks until its last meeting, it may prefer to move in steps, that is, change the outlook on inflation now and cut rates in December.

D K Srivastava, chief policy advisor at EY India, says, "We are expecting a 0.25% reduction in the repo rate as the food prices are falling and are expected to fall further as fresh food supplies are expected to flood the market which may further bring down inflation." Repo rate is the rate at which the central bank lends overnight money to banks. It is also a signalling rate.

The October 4 policy will go down in the history of monetary policy as the first that will be decided by a committee rather than by the governor which was the practice until recently. Economists say when the fresh Kharif crop trickles into the market over the next few months, inflation could fall further. Vegetable prices could completely reverse their summer ascent of 1.1%. Furthermore, higher pulse production on the back of a rapid increase in sowing could reduce inflation by another 0.4%.

The RBI has two objectives – to reach its 5% inflation target in early 2017 and keep real rates at the 1.5-2% range. Marrying the two would open up space for easing by 0.5%, says another economist. D K Joshi, chief economist at Crisil, said, "We don't expect any change in interest rates until the Monetary Policy committee (MPC) is certain about the inflation, considering the volatile food prices that we have. So we expect a 0.25% in December when we are more certain about inflation."

If the food prices continue to fall then CPI inflation could fall to under 4.5% in the January-March 2017 period. Moreover, inflation is likely to remain below the RBI's early 2017 target of 5% for the next 12 months, opening up space for monetary easing in the months ahead.

manju.ab@dnaindia.net