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Urjit Patel seen seizing last chance to spur growth in RBI monetary policy

LiveMint logoLiveMint 31-07-2017 Anirban Nag

Mumbai/New Delhi: A year ago, India had Asia’s fastest growth and inflation. Then Prime Minister Narendra Modi took away most of its money and both indicators slowed, bolstering expectations the central bank will cut borrowing costs for a final time this cycle as pressure mounts for a stimulus.

The Reserve Bank of India’s (RBI) six-member monetary policy committee will lower the repurchase rate to 6% from 6.25%, according to 39 of 55 economists in a Bloomberg survey before Wednesday’s announcement. The rest see no change. The reduction would bring the benchmark rate to the lowest since 2010 and mark a U-turn from just six months ago, when governor Urjit Patel jettisoned an accommodative bias for a neutral policy setting.

Consensus has built for a cut because it’s seen as Patel’s last chance through 2018 to spur the economy before the US Federal Reserve reduces its balance sheet, forcing emerging markets to keep pace. India’s record-low inflation is also flattered by last year’s prices and low global food costs, which are expected to reverse in coming months.

“Given that the inflation reading has further surprised with a sub-2% print, we find some room for RBI to be accommodative,” said Madhavi Arora, an economist at Kotak Mahindra Bank Ltd in Mumbai, who predicts a reduction on Wednesday. “However, we reckon that the room for further monetary accommodation remains limited.”

Consumer prices rose 1.5% in June, below the RBI’s April-September forecast range of 2% to 3.5%. It will end 2017 around the medium-term target of 4%, according to the median estimate in a Bloomberg survey. Economists also reduced their growth projections for the previous quarter as loan-growth hovers near a record low and job losses mount after Modi last year surprisingly scrapped 86% of currency in circulation.

Earlier this month, Modi’s top economic adviser Arvind Subramanian said India was undergoing a “paradigm shift” in prices and called upon policy makers to reflect “very, very, carefully” upon June’s unprecedented inflation and soft industrial output. There were also signs of dissent within the MPC, with one member breaking ranks for the first time to urge a sharp 50 basis point cut.

Baking in a cut

Besides angering the government, a hold on rates this week would risk roiling the stock and bond markets that have pretty much baked in a 25 basis point reduction. Lower interest rates, on the other hand, could pressure the rupee that has strengthened some 6% this year by offering investors who borrow in dollars the highest carry returns in Asia.

Tuuli McCully, Singapore-based head of Asia-Pacific Economics at Bank of Nova Scotia, says majority of the MPC is committed to an inflation-targeting monetary framework and are strong advocates of central bank independence.

“Therefore, they will likely see through temporary dips in headline inflation and instead focus on core inflation that has not eased in tandem with the headline rate,” McCully said. “They are also likely to refrain from voting according to the government’s preference of looser monetary policy.”

What deepens the quandary is that while the markets are betting on a cut, Patel’s team has been mopping up excess funds in the banking system, effectively tightening policy to ensure it doesn’t fuel inflation.

The RBI withdrew Rs200 billion on 6 July and 20 July through open-market operations and announced more for August. It has also been using regular tools to drain funds and move to neutral liquidity from a surplus.

“The RBI should cut rates by at least 50 basis points if they want to help genuine borrowers but the probability of that happening has significantly reduced,” said Rupa Rege Nitsure, chief economist at L&T Finance Holdings Ltd. “If they cut rates after this, as a monetary economist, it does not make any sense to me. As things stand, the RBI’s reasons for maintaining their neutral stance remain unchanged.” Bloomberg

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