Monetary Policy – Has it entered an “accommodative” phase??

The monetary policy committee’s decision to cut repo rate by 25 basis points was almost a certainty and did not come as a surprise. With inflation remaining subdued for quite some time now and growth not witnessing a pick-up, this was the most appropriate course possible. Even though the committee did not change its stance from “Neutral”, two successive rate cuts makes it more like an “accommodative” stance. Rate cut has been effected despite the fact that CPI inflation has rose to 2.6% in Feb’19 from 2.1% in Jan’19 reflects the confidence of committee is a benign inflation going forward. Barring an external shock in the form of crude price rise or food price rise, the committee seems on course for a few more rate cuts. Here is a look at the details.

While each policy document looks almost like the previous one (!), a closer reading reveals significant changes and highlights the dynamic nature, particularly of global economy. The most important development over last two months since the previous policy meeting is that domestic “output gap” has become negative. Negative output gap means the economy is producing less than its potential due to weak demand. While a negative output gap signal weak inflation prospect, it also implies lower growth.  Demand weakening, itself, could have been due to earlier rate increases or lower government expenditure. Growth is also getting impacted by a slowdown of global economy with decline in exports for Jan-Feb’19, the other highlight of this monetary policy document.

Even though the policy statement talks about negative output gap, it also mentions that CPI excluding food & fuel, which had been staying above 5% for quite some time, has increased from 5.2% in Jan’19 to 5.4% in Feb. While this looks contradictory to the earlier statement, the reason could be that CPI excluding food & fuel comprises of a small list of items, including service products such as healthcare & education, and do not reflect the aggregate demand-supply condition of the economy.

Other than the monetary policy, RBI also made another set of announcements pertaining to other aspects of banking. Among those was the announcement to defer its earlier direction on linking loan products to an external benchmark by April’19. The linking was essential as the rate cuts do not translate into an effective gain for the economy due to ineffective transmission mechanism, unlike the rest of the world. From that perspective, today’s deferral comes as a disappointment. It may be noted that SBI has initiated to link some of the loan and deposit products to repo rate last month. If not a direction from RBI, the SBI move may help improve transmission mechanism.

Another interesting number that merits attention is the total liquidity injected into the economy by RBI which stands at close to Rs 3 lakh crore during FY19. This contrasts sharply with FY18 when it absorbed excess liquidity from the market. RBI probably deserves credit for being able to contain inflation despite such sharp increase in liquidity.

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