Wednesday, October 05, 2016

Urjit Patel's maiden monetary policy marks a significant shift

Make no mistake, RBI Governor Urjit Patel's maiden monetary policy statement (embodied in the MPC resolution) marks a significant shift in the approach to inflation.

The framework is the same as in Rajan's time, the mandate is the same (4% plus or minus 2% inflation) but the interpretation of the mandate is quite different. Rajan was committed to a 'glide path' whereby inflation would be brought down to 4% by 2018. Patel did not say so explicitly at any point but the message is pretty clear: 4% now is a target to be attained over five years with the flexibility to depart by 2% in the interim.

At the media interaction, Patel was asked whether the target of 4% by 2018 was still in place. He did not give a straight answer but read a statement on the mandate given to RBI. Most people would have read between the lines and understood.

How do we know? First, we have the 25 bp rate cut. True, food inflation has moderated. But we are looking at 5% inflation by 2017 with significant upside risks. The MPC would not be taking chances with a rate cut if it were fixated on bringing inflation down to 4% by 2018. It can afford to take chances only by interpreting the mandate more broadly.

Secondly, there was mention of the real interest rate target being lowered from 1.5-2% to 1.25%. At the present repo rate of 6.25%, this permits an inflation rate of 5%. The point was made that the real rate is not a fixed number, which means it can drift even lower. That gives even more flexibility in respect of lowering the interest rate.

Then, there's a softer approach towards NPAs- pragmatism will be the name of the game. The governor is keen to ensure that credit flows to industry are not stalled because of NPAs.

So, once again, the pundits have been proved wrong. They said that Patel's appointment marked continuity with Rajan's policies because Patel had authored the report on inflation targeting. They said he was a hawk who wouldn't budge on interest rates. They said two out of the three outside experts on the MPC were also hawks. What we have in the latest policy is six doves.

The pundits may also have been wrong in saying that the government did not persist with Rajan mainly because they didn't approve of some his speeches. I have argued in my blog that, within the Sangh parivar, there was considerable discomfort with the interest rate regime.

Finally, we were warned that any interest rate cut in the context of RRexit and Brexit would spark an exodus of foreign funds, the rupee and the stock market would collapse and economic doom was round the corner. Nothing of the sort has happened.

So much for punditry.


3 comments:

Unknown said...

Sad though that this will lead to higher inflation expectations and all good work done earlier going down the drain. Another way to read up easing of NPAs is a green light for crony socialist. All promoters who raked up NPAs will continue in their place in false hope of growth. A timid govt gets a timid governor in place.

Aman Pratap Singh said...

Sir what will happen if Indian government becomes bankrupt?

Sapan said...

Does this mandate of 4% inflation take in to account the GST reform, that is likely to get implemented from Q1-2017? Empirically, any country implementing GST has witnessed rise in inflation in its initial 2 years.

A mandate of 4%, considering GST at the back-drop, is quite tenable; not sure achievable or not.