The First Monetary Policy Committee: A Summary

The Reserve Bank of India on Wednesday, 4th April 2018 through their Bi-monthly Monetary Policy Statement, 2018-19 announced that RBI will maintain the neutral stance for the fourth time. The report indicated RBI’s status quo attitude by keeping the repo rate “unchanged” at 6%, the reverse repo rate at 5.75 % and the marginal standing facility (MSF) rate and the Bank Rate at 6.25 per cent to achieve the medium-term target for Consumer Price Index (CPI) inflation of 4% within a band of +/- 2%. The Policy is a pleasing revelation for the market. The decision was focussed to the macroeconomic objective of modifying downwards the inflation projections and upwards the growth numbers. The stance concurs with the theory of Inflation targeting through interest rate policy instruments to achieve the objective of improved growth. The report mentions five major considerations that led to the decision.

1. The global economic activity has gained momentum after third quarter in Advanced Economies like US, Euro Area and Japan along with the Emerging Market Economies such as China, Brazil, South Africa and Russia. Crude oil prices have witnessed volatility with prices lowering down in February 2018 due to increased US production from Multi-year high to strengthening back again in march due to significant fall in supply because of rebalancing by OPEC and Russia and depleted US inventories.
2. Crude oil prices impart considerable uncertainty to the approaching stance.
3. Volatility in Financial markets increased in February-March fuelled by uncertainty regarding the velocity of normalisation of US monetary policy, and concerns surrounding global trade. Yields in other major AEs have fallen while divergence can be seen in EMEs due to country-specific factors.
4. The behaviour of components of aggregate demand. Consumption, Government Spending and Gross Fixed formation (proxy for investment) have improved from third quarter to fourth quarter while the Net exports component has decreased due to increased imports and decrease exports due to GST-related working capital distribution.
5. CPI inflation of food and fuel has decreased while the housing group inflation has shown significant increase due to HRA increase for Central government employees. While status quo on policy rates were anticipated, the rate can be expected to be same due to RBIs objective of higher growth expectations and lower inflationary forecasts to enhance the market confidence and bond markets. 

Every policy maintains its stance, ceteris paribus. Few issues may lead to divergence of reality from expectations like, revised MSP announced in the FY19 Union Budget, uncertain impact of HRA revisions by various state governments, another round of fiscal slippage, industrial outlook survey of RBI indicating rise in input and output prices and volatility in crude oil prices that may put pressure on inflation during the coming month. The success of the decision will depend on how close reality syncs with expectation and whether RBI is able to maintain the Output-price relationship in the presence of expectations.