The latest Monetary Policy Review of the RBI under Shaktikanta Das has unexpectedly cut rates, indicating far greater consonance with the government’s objectives.

• RBI has unexpectedly cut rates by 25 basis points in its latest policy review meeting.
• With this stance, the Governor has firmly shifted the direction of the Central Bank from inflation targetting to growth.
• The Central Bank’s approach is quite similar to the government, which has adopted an expansionary and populist approach in the run-up to elections.
• After the appointment of former bureaucrat Shaktikanta Das, RBI’s acrimony with the government seems to be a thing of the past.

When former bureaucrat Shaktikanta Das took over the reins of RBI after the resignation of Urijit Patel, he was widely expected to be the Centre’s man in the Central Bank.

As per expectations, the RBI is now singing a tune similar to the government on economic policy. This is evident from the RBI’s latest monetary policy review that was released today.

The monetary policy committee (MPC) of the Reserve Bank of India announced an unexpected cut in the repo rate by 25 basis points. This rate cut, which takes the repurchase rate to 6.25%, comes nearly a week after the Modi government announced an expansive and populist budget that targeted small farmers, lower middle class and unorganised sector workers in particular.

WHY THIS SUDDEN U-TURN?

In its review in October, the RBI had put rate cuts off the table. Urijit Patel had stood strongly by his aim to keep inflation under 4% as mandated by the RBI. Shaktikanta Das and brought back the focus to growth and monetary easing. The MPC has also changed its policy stance to ‘neutral’ from ‘calibrated tightening’ in December 2018.

The governor has justified the dovish stance by citing the sharp slowdown in inflation to an 18-month low of 2.2% in December. RBI estimates that inflation will not cross its medium term target over the next ten months.

Moreover, the US has also adopted a dovish approach opposed to rate hikes last year, providing relief to emerging markets like India. Government officials have praised the cut by RBI. Economic Affairs Secretary Subhash Garg stated that the rate cut “underlines low inflation and high growth path for India for 2019-20.”

Some economists have countered that this surprise move is election friendly and compromises on RBI’s inflation-fighting role. In the normal scheme of things, central banks are known to just shift the stance in one review and cut rates in the next one. Aurodeep Nandi, India Economist, Nomura, Mumbai, comments, “The MPC’s U-turn – from ‘calibrated tightening’ in December (which effectively ruled out a rate cut) to a decision to cut rates in February is a surprise. We did expect a rate cut later this year, but the front ended delivery is a surprise even relative to our expectations.” Sill others feel that RBI is right to bypass the conventional route.

A PAST FULL OF STRESS

Under Shaktikanta’s predecessor Urijit Patel, the RBI and the government were at constant loggerheads over a number of issues. Patel resigned after a much publicised battle ensued between the Centre and the RBI. Deputy governor Viral Acharya had also spoken openly about the government interfering in the autonomy of the RBI. He had stated on October 27, “…(Governments that) do not respect [the] central bank’s independence will sooner or later incur the wrath of financial markets, ignite economic fire, and come to rue the day they undermined an important regulatory institution”.

The government viewed the RBI order on NPA classification as extremely harsh towards banks. It also accused the RBI of laxity in the PNB scam and wanted it to cut interest rates. To top it all, the government wanted RBI to transfer its excess reserves to the state exchequer, which would help it boost the economy.

ALL’S WELL THAT ENDS WELL?

Even on other issues, the RBI seems to be concurring quite well with the government at present, and far more frequently. On the issue of reserves, Das affirmed that the payment of surplus was a part of the RBI act and the government was free to use the transferred reserves as it deemed fit. Economists have expressed fear, however, that these reserves could be used for electoral sops and also affect RBI’s credit rating.

By end-January, the RBI removed lending restrictions on three of the eleven public sector banks – Bank of India (BoI), Bank of Maharashtra (BoM) and Oriental Bank of Commerce (OBC), which was one of the key demands of the government to improve credit growth.

From being aggressive on reforms earlier, the Modi government is now taking measures to relieve sections of the economy that have gone through disruption from Demonetisation and GST.

The RBI seems to be fully on board with this sentiment as well. Obviously, the rate cut helps the middle class that is repaying loans. In addition, to further ease access to finance for small farmers, the RBI has raised the limit of collateral-free farm loans by banks to Rs 1.6 lakh from Rs 1 lakh currently.

Even as Das claims to have factored budgetary proposals in, there is fear among some quarters that the fiscal deficit target of 3.4% is ambitious and borrowing could increase sharply, thereby increasing inflation.

The appointment of a bureaucrat to the top position at RBI is not unprecedented. Before this, Duvvuri Subbarao was appointed by the UPA government. He was a dove as well in his initial years, making six rate cuts between October 2008 and April 2009 in line with the UPA’s objectives, although he had to tackle the aftermath of Lehman. With the appointment of Shaktikanta Das, even the Modi government seems to have also buried the hatchet with RBI for the present moment.