The RBI policy decision signals a significant change in stance. As a flexible inflation targeting bank, governor Rajan had reiterated numerous times that bringing inflation down was critical for a sustainable growth trajectory. In recent years, RBI’s commitment towards inflation targeting has borne fruit and, aided by falling commodity prices, average CPI inflation has moved from around 9.5% y-o-y in FY14 to around 5% y-o-y expected this fiscal.
The RBI policy decision was significant for two reasons. First, because it suggests that RBI is now more confident that the economy is moving to a stable low inflation regime. Its forecast of around 4.8% inflation by March 2017 is, of course, supported by the global commodity price slowdown. More pertinent however, is that RBI is taking good note of the government’s resolve to play an active inflation management role where necessary and its efforts to curb the fiscal deficit.
The second significance is that armed with this comfort on inflation, RBI is playing a much more active role in supporting the recovery in the economy at a time of muted global growth.
Both these things are good news for the Indian economy. A stable, low inflation ecosystem and an accommodative policy would transmit into lower deposit and lending rates and would help accelerate domestic demand and investment.
From the perspective of bond markets as well, the policy document gave a clear articulation related to two critical aspects of the market: The role of foreign investors in the bond market and the streamlining of SLR holdings of banks so as to dovetail with global Basel liquidity requirements.
Over the years, FPIs have become an important market constituent holding close to 100% of the allowed G-Sec limit. This meant they held around 3.5% of outstanding government bonds. There was an expectation that there would be some announcement raising the current limits. The RBI acted decisively in this regard.
More importantly, it sought to mitigate significant rate and currency volatility due to such flows by giving a calibrated road map for such investment over the medium term (5% of outstanding G-Secs by 2018) as well as by allocating this limit across central government issuances, corporate rupee bonds and state government issuances.
In the short term, it is interesting to note that the timing of the FPI limit hike has probably been done in a manner that takes into account upcoming Fed policy meetings, and to minimise volatility and market disruptions due to the expected hike in US rates.
To conclude, RBI has given a message that it does see the economy moving into a stable low inflation regime and, hence, is able to adopt a more accommodative policy role. This would transmit into a lower interest rate regime that would support domestic demand/investment and growth.
By Shilpa Kumar
The writer is head-global markets group, ICICI Bank
