Gloves Off in Spat Between India's Central Bank and Government

  • Record low inflation seen opening room for India to cut rates
  • Forecast errors overstated inflation, economic adviser says

Nine months after setting up an independent committee to oversee monetary policy, Prime Minister Narendra Modi’s government is expressing frustration that the Reserve Bank of India chose not to cut interest rates or accept meetings to discuss the economy. 

Economic conditions warranted a substantial monetary easing, chief economic adviser Arvind Subramanian said hours after the central bank kept its benchmark repurchase rate unchanged at 6.25 percent. RBI governor Urjit Patel told a media conference that all MPC members had declined requests from the finance ministry to meet ahead of the decision.

Leading up to the two-day RBI meeting, Finance Minister Arun Jaitley said growth and investment needed to improve and any finance minister under these circumstances "would like a rate cut." After the decision, he told Bloomberg TV that he thought a briefing from the finance ministry on the economy would have been "an important input" for the central bank, while noting "respect" for the RBI’s jurisdiction.

India’s Finance Minister Arun Jaitley tells Bloomberg TV he has "respect" for RBI’s rate jurisdiction.

Source: Bloomberg

"There is some level of divergence of views on interest rates between the government and the RBI," said Sujan Hajra, chief economist at Anand Rathi Securities Ltd. in Mumbai and a former central banker himself, adding this was common. "Clearly the RBI has downgraded its view on inflation and with that the stance will also have to soften."

Making the government’s case, Subramanian said at a media conference in New Delhi that there was a "plausible alternative macro-economic assessment," and that forecast errors have been "large and systematically one-sided in overstating inflation."

The RBI did slash its inflation projections, a big departure from April when Patel said growing price pressures needed "close vigilance."

Read more: India Keeps Interest Rates Steady, Monitors Inflation Drop

And that may have opened the door to more easing.

“We believe this paves way for a rate cut in the August policy meeting as the consumer-price index is expected to remain subdued,” said Anubhuti Sahay, head of South Asia economic research at Standard Chartered Bank Plc, referring to the cut in inflation projections.

Softer forecasts

The $2 trillion economy has been softer than the central bank forecast. Consumer price inflation rose just 2.99 percent in April from a year earlier, the weakest on record. Core inflation -- which strips out volatile food and fuel costs -- rose 4.5 percent in April from a year earlier, lower than the 4.8 percent rise seen in March 2017.

A 5.5 percent rise in the rupee this year is helping to drive down the cost of imports, and along with softer crude prices, inflationary expectations appear to be subdued.

Gross domestic product expanded by 6.1 percent in the January to March quarter, the slowest in two years, amid the aftershocks of Modi’s decision to ban high-denomination notes in November in a bid to curtail corruption. For the whole year to March, the economy grew 7.1 percent, down from 8 percent in the previous year.

The RBI now expects headline inflation at 2 percent to 3.5 percent in the first half the fiscal year ending in March, down from a forecast of 4.5 percent in April. In the second half of the year, the bank sees inflation edging up to 3.5 percent to 4.5 percent, also lower than the 5 percent previous forecast. It also forecast lower growth.

Changing Views

The cut to inflation follows months of changing views at the central bank. In April it raised the reverse purchase rate to tighten monetary conditions and in February it moved to a hawkish monetary policy stance after two years of accomodative policy. The RBI held rates steady in December, when most economists were expecting it to cut rates in the wake of the note ban. In October, Patel cut rates even though a majority of economists were expecting him to stand pat.

The cut in inflation forecasts was cheered by investors. The yield on benchmark 6.79 percent notes due May 2027 dropped seven basis points to 6.57 percent Wednesday.

Read more: Why India’s Zombie Debt Imperils Modi’s Plans: QuickTake Q&A

The RBI’s downbeat assessment for both growth and inflation comes at a time when credit growth is at its lowest in 25 years and the central bank is tackling a huge surplus of liquidity in the banking system and grappling with a pile of non-performing loans.

"The key concern remains the state of banks’ balance sheet including much needed recapitalization," said Bekxy Kuriakose, head of fixed income at Principal PNB Asset Management Company. "The RBI appears to be against taking premature action on the rate front."

That is partly because the monsoon soon is progressing normally and is poised to boost rural incomes. That along with higher allowances for workers in the public sector is likely to bolster activity.

"We believe that a case for a rate cut will be strengthened only with a downside surprise to the second-half inflation estimates," Madhavi Arora and Upasna Bhardwaj, economists at Kotak Mahindra Bank Ltd. in Mumbai. "We maintain our expectation that the RBI will likely remain on a pause as it continues to watch out for the evolving inflationary conditions."

— With assistance by Kartik Goyal, and Subhadip Sircar

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