Indian monetary policy moved into a new era as the newly-formed monetary policy committee (MPC) cut the country’s key rate by 25bp to 6.25% at its first meeting on 4 October. Taking advantage of the leeway provided by the recent fall in inflation (at 4.3% year-on-year (YoY) in September) and good monsoons, the Reserve Bank of India (RBI) was able to maintain its accommodative policy stance.
A first for Dr. Patel and the MPC
This decision by the RBI’s MPC was the first under Dr. Urjit Patel, who took over as central bank governor when Dr. Raghuram Rajan’s term ended on 4 September.
While the departure of Dr. Rajan had financial markets guessing on the direction of monetary policy, the nomination of Dr. Patel as governor was seen as a clear sign of policy continuity. Dr. Patel had been deputy governor in charge of monetary policy since January 2013 and played a critical role in defining India’s inflation targeting framework through the recommendations in the 2014 Patel Committee report.
This report had also recommended the formation of the MPC, which is now responsible for monetary policy decisions. The committee comprises six members, three from the RBI and three experts nominated by the government, with a deciding vote for the RBI governor should the members be tied.
Slight reduction in real rate target allows for further cuts
The MPC has maintained policy continuity in most respects. It has retained the RBI’s target of 5% CPI inflation by March 2017 and the longer-term target of 4% (+/- 2%) as well as the accommodative policy stance initiated by Dr. Rajan. One notable change, however, was the lowering of the RBI’s real interest-rate target, from a previously stated objective of 1.50%-2%, to a more dynamic target of 1.25%.
This, combined with likely lower inflation thanks to the normal monsoons, should open up room for another 50bp of rate cuts over the next six months.
Exhibit 1: Recent fall in inflation opens the way for lower official rates
Source: BNP Paribas Investment Partners as of 21/11/16
India’s GDP growth to accelerate
The RBI’s decision has been welcomed by investors and companies since it should help to boost India’s GDP growth. The RBI continues to expect growth of 7.6% for 2017, with the positive momentum from higher rural and urban consumption being partly offset by global headwinds hitting India’s exports.
For 2018, the RBI expects growth to accelerate to 7.9%, supported by positive structural changes such as the implementation of the goods and services tax (GST) and the steps taken to attract higher foreign direct investment.
In line with this upbeat outlook, the International Monetary Fund has in October raised its 2017 growth forecast for India from 7.4% to 7.6% , stressing India’s robust growth momentum.
This article was written by Paul Milon and Brijesh Ved
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