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India’s monetary policy gets political

India’s monetary policy gets political

A long-simmering spat between the Indian government and the country’s central bank came to the surface on Wednesday, after finance minister Arun Jaitley weighed in with a view on the direction of monetary policy.

In an interview with CNBC-TV18, Jaitley said that the Reserve Bank of India’s monetary policy committee should cut interest rates, given the country’s slowing economic growth and relatively low inflation.

Under prime minister Narendra Modi, the government has been pushing for economic reforms, including the controversial demonetisation of the economy, through the removal of more than 80% of the notes in circulation. The split has worried some foreign analysts.

‘I think the bigger issue is that the government is attempting to erode the independence of the RBI by pressuring it into loosening policy even further,’ Shilan Shah, India economist at Capital Economics in Singapore said. ‘Having meetings between the finance ministry and the RBI is ill-advised because it erodes the credibility of the RBI.’

The monetary policy committee, led by governor Urjit Patel, declined a request to meet by the finance ministry prior to the decision. The RBI decided to keep the repo rate unchanged at 6.25% on June 7, despite inflation figures continuing to be weak relative to India’s historical average. Core price inflation has fallen to below 4% since November 2016 and the latest quarterly GDP figure is at its weakest in two years.

Against this backdrop, the government wants to spur growth and investment by reducing borrowing costs.

‘The finance ministry wants to show that growth has picked up and that demonetization wasn’t a big factor. There are political considerations behind wanting lower rates,’ said Ashish Goyal, head of emerging markets equity at NN Investment Partners.

For its part, the RBI does not want to create an imbalance in the rates markets by cutting too much, too soon. Combined with external factors such as the UK elections, Middle East tensions and the US Federal Reserve’s actions, it is adopting a more wait-and-watch approach, said Mihir Kapadia, CEO of Sun Global Investments in London.

‘This has been a hard-fought battle on inflation by the RBI,’ said Credit Suisse’s Indian equity strategist, Neelkanth Mishra. Mishra, along with most analysts, expect one rate cut in 2017 as there is a case to be made for inflation to unexpectedly cross the RBI’s upper limit of 6%.

Upward pressure

The second half of the year could see upward pressure on consumer spending. Farm loan waivers, healthy urban consumer finances, a possible pay rise for government employees, as well as a declining marginal cost of funds-based lending rate could leave the population with more disposable income, according to Sanctum Wealth Management’s CIO Sunil Sharma. 

Going against consensus, Capital Economics’ Shah is convinced the next move in rates is going to be upwards. ‘There’s been a rebound in consumer demand and food inflation should pick up in the second half of the year as well,’ he said.

Whatever the outcome, he believes the interplay between the government and RBI is set to continue.

‘The government has been putting pressure on the RBI for many years now, so I don’t see that changing.’ Shah said. ‘But at the same time, the RBI has, perhaps, shown more independence in the face of government pressure than many would have expected. So for that, you have to give it credit.’

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