RBI Policy – An apparently benign policy statement, uses smart messaging

RBI announced its August policy statement on 05-August. While it appeared to be a benign policy statement with routine data estimate tweaks, there were several messages that were rolled into the RBI policy.

RBI policy with several messages

The RBI policy was largely along expected lines. The repo rate was held at 5.25% by a unanimous vote of MPC members. The stance of the policy was also held at “Neutral.” As a result, the linked rates also remained the same. The SDF rate remained static at 5.00%, while the MSF rate and the bank rate stayed at 5.50%. Interestingly, the RBI MPC upped the GDP growth estimate for FY27 by 10 basis points from 6.6% to 6.7%. At the same time, the inflation estimate for FY27 was lowered by 10 basis points from 5.1% to 5.0%. Amid these data tweaks, there were several interesting messages.

Sticking to the data-driven approach

The RBI governor, Sanjay Malhotra, and the deputy governor, Poonam Gupta, have consistently maintained a stand that RBI policy shifts would be drive more by data and less by estimates of how macros pan out. That has been a debate globally, and even the US Federal Reserve under Kevin Warsh has preferred to craft policy based on past data points. That approach has several advantages as it is consistent and also helps to manage inflation expectations more effectively. Even for the bond markets, a data driven approach to monetary policy is much easier to model and price. This data-driven approach is likely to be the theme of RBI policy in future too.

But, letting wisdom rule over knowledge

The second message that the RBI has sent out in the policy is that it will prefer to let wisdom rule over economics. There is a famous saying in the English language that “Being aware that tomato is a fruit is knowledge; but not putting it in a fruit salad is wisdom.” That is the approach that the RBI has taken in this policy. While it has used data as the base, it has laced it with decisions that are more wisdom-based. For instance, inflation at over 5% is a matter of concern, and any level closer to 6% can be a trigger for rate hikes. However, wisdom suggests that much of this inflation may be ephemeral and in a tough choice between prices and growth, the RBI has chosen GDP growth.

Keeping rupee stability outside RBI policy

One of the key demands in the last few months has been about using rate hikes to boost the value of the rupee. The latest policy is clear that the rupee stability and repo rates will be kept separate. For now, the rupee has got respite from the huge flows through the FCNR(B) scheme as well as through OFCBs and ECBs. With current inflows at $41 billion and expected flows of $90 billion by end of September; the RBI does not need to even consider rate hikes to defend the rupee. While that strategy has worked selectively, it is a risky strategy which is fraught with risks. The current policy has underlined that rates and rupee will be kept separate. For its smart messaging, this policy does stand out!