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Monetary policy: Two cheers but not three

, December 16, 2014, 0 Comments

monetary policy india-MarketExpress-inThe much awaited monetary policy of December 2014 miffed the markets and the economy. Anticipating a rate cut. The markets believed that RBI had a window to cut the repo rates. A cut in repo rate would provide a stimulus to economic growth which needs to kick start. While fulfilling the objectives of stimulating economic growth and controlling inflation; many a times RBI faces a policy dilemma.

In previous past despite the economy wanting the rate cut to kick start growth, the pressures of taming inflation remained paramount leaving RBI no choice other than being hawkish. The current account deficit at comfortable levels there are no pressures on value of rupee vis –a vis the dollar. At this juncture an accommodative monetary policy stance would have been ideal. Much to chagrin of the markets, RBI remained neutral. The stance of monetary policy remained unchanged. The press meet that ensued, Dr Rajan elucidated all the factors that held him back from cutting rates

The fall in global crude oil prices in couple of months was thought to be cyclical rather than structural. Besides RBI wanted to make sure that the change in monetary policy stance to be more accommodative would not need to be changed abruptly if inflation soars. The fall in inflation is attributed to base effect which would start wearing of from December.

As we go into the next calendar year, global factors would play an increasing role in particular, The US Fed might look to raise interest rates in the third quarter of the calendar year depending on the data. So far macroeconomic data of US economic growth and unemployment have been buoyant, if not stellar. The latest non-farm payroll data released in December 5, this year indicates an increase in 321000 jobs which is highest since Jan 2012.

If and when a rate rise happens in the US, it is bound to have repercussions on the rupee exchange rate. Understandably to cushion this, the RBI has been building up its currency reserves since last July. The second line of defence to protect the currency is high interest rates so that the interest differential between India and US remains high enough to attract dollar flows.

The cautious stand of RBI to protect the external value of rupee and keep inflation on a tight leash were taken at the altar of economic growth. Looking at the global cues many Central banks across the world is promoting economic growth .For instance China recently cut its interest rates, Japan increased its quantitative stimulus and Europe is looking to increase its quantitative easing program. Such accommodative monetary policy is essential given the deflationary conditions in Japan and Europe.

It would be a catalyst in stimulating economic growth. Among leading economies except Russia , India’s central bank is an outlier. India too should have resorted to accommodative monetary policy.