As expected RBI keeps rates on hold – but is this the calm before the storm? - II

Fourth Bi-Monthly Monetary Policy Statement due on October 4, 2016

Monetary Policy                                                                                                     2016-17

Please see my August 11, 2016 blog titled “As expected RBI keeps rates on hold – but is this the calm before the storm?”

One element of uncertainty appears to have been removed when a month ago government appointed Dr. Urjit Patel, then Deputy Governor of the Reserve Bank of India, as the replacement for Governor Rajan. Dr. Patel has been closely associated with the RBI’s move towards inflation targeting. While only time will tell whether he carries the same zeal for controlling inflation as Rajan, I would suspect that at least initially he will follow the same course.

The key policy rate – the repo rate – will now be set by the Monetary Policy Committee (MPC) by a cast of votes. The uncertainty regarding how rate setting by the Monetary Policy Committee will influence the course of the current monetary policy remains. Three outside members have been announced: Pami Dua, Chetan Ghate and Ravindra Dholakia, all academics. The other three members are from the RBI, with Governor Patel having a casting vote.

My own sense is that all three RBI members will vote in line with each other – RBI careerists typically don’t rock the boat. That being so and with Governor Patel having the casting vote in the MPC, I see the will of the RBI prevailing. 

Yet, it will be interesting and significant to see the voting pattern of the outside members of the MPC - we have no clue as to their thinking, and it will take some time before a steady pattern emerges about their stance on monetary issues. 

What is the course the RBI members prefer? One, they would like to keep the real interest rate in the region of 1.5%- 2%. Could Governor Patel change the stance on this? This is a possibility, but to my mind possibly not for now. Two, if there is no drastic change for the better (the last monetary policy statement suggested some worsening) in the course of inflation for the rest of the financial year – 5% by March 2017 – keep rates on hold.

If RBI members vote straightaway for a reduction in the repo rate, based on my current reading of the data, my view is that the RBI would lose some credibility on its recently gained inflation fighting credentials.