It was taken for granted by economists and analysts this week that India’s central bank would cut its lending rate by at least 25 basis points, from 6.25% to 6%. On Wednesday, the Reserve Bank of India complied, offering its first repo rate cut (the rate at which it lends to banks) in 10 months.

The industry has welcomed the move, which is expected to increase liquidity and hence boost activity in the economy, but experts pointed out that the RBI’s monetary policy committee had cited the same economic outlook as a reason not to reduce rates in its previous meeting two months ago.

RBI Governor Urjit Patel defended his decision to cut rates citing factors such as falling consumer inflation, which reached a record low of 1.54% in June and what he said was a smooth roll-out of the goods and services tax.

While it is true that inflation has been falling each month since March, when it was at 3.81%, the effects of the tax overhaul with the implementation of the GST are still to be seen. Its impact on prices will only start becoming evident once the first set of returns are filed in September and manufacturers claim credits for taxes paid by them.

Experts said there was an inconsistency on the part of the RBI, which had been using the same set of data and circumstances to arrive at different policy decisions.

Speaking to, Madan Sabnavis, principal economist at CARE Ratings said that the RBI seemed to have taken the decision to cut rates only to boost market sentiment. “I tend to think that the committee statement this time was the same as the last one,” he said. “Inflation and other macroeconomic indicators remain largely the same but they have largely tried to change perceptions through this move.”

A comparison of the text of June and August’s monetary policy resolutions show that the committee had similar observations both times even as it took different decisions.

The RBI’s June statement said:

“The current state of the economy underscores the need to revive private investment, restore banking sector health and remove infrastructural bottlenecks. Monetary policy can play a more effective role only when these factors are in place.”

The language in August’s resolution is nearly the same – even though the committee ended up recommending a rate cut, the RBI’s key monetary policy tool.

“On the state of the economy, the MPC [monetary policy committee] is of the view that there is an urgent need to reinvigorate private investment, remove infrastructure bottlenecks and provide a major thrust to the Pradhan Mantri Awas Yojana for housing needs of all.” 

CARE Ratings was one of the few agencies that had predicted a status quo after Tuesday’s monetary policy committee meeting while most people were hoping for a rate cut, because the impacts of major determinants on prices such as GST, farm loan waivers given out by various states and the revised salaries and arrears under the seventh pay commission are yet to play out.

The RBI’s committee also referred to these factors in its review, as it had in previous ones, but decided to cut rates anyway.

“There are several factors contributing to uncertainty around this baseline inflation trajectory. Implementation of farm loan waivers by States may result in possible fiscal slippages and undermine the quality of public spending, entailing inflationary spillovers,” stated the monetary policy committee’s resolution.

However, the RBI did try to caveat its decision to lower rates despite mostly identical economic conditions by saying that inflation could rise to the 4% mark by the fourth quarter of the current financial year.

New system

The monetary policy committee was formed last year, to streamline India’s efforts to manage inflation after the RBI decided to keep consumer inflation at or below 4%. The six-member panel comprises three RBI officials and three government appointees who meet every two months and decide on the RBI’s interest rates.

A State Bank of India note from July 31, two days before the August rate cut, examined the working of this new body and concluded that its approach to economic indicators was inconsistent. The note pointed out that opinions of the committee have changed “abruptly” in successive meetings regarding inflation outlook.

“The October policy stressed on inflation target being achievable but concerns about inflation became heightened in the very next policy and curiously that stance has continued since then,” the note said. “Though in the most recent policy [in June] the members have accepted that inflation is indeed coming down, they have chosen to adopt a wait and watch stance and there are still some lingering concerns about core inflation.”

Inflationary trends

In June, Rathin Roy, Director, National Institute of Public Finance and Policy wrote in Business Standard about similar inconsistencies in earlier policy statements and said that the monetary policy committee changed its stance too many times in consecutive meetings without strong grounds for doing so.

“The MPC appears to have reversed its stance on inflationary expectations and reversed its call on the transitory effects of demonetisation. It seems to have taken a new normative call on the effectiveness of monetary policy in the presence of structural constraints that have been present for some time now,” he wrote.

Some experts, however, argue that the RBI’s decision to cut rates this time came in the wake of a sharp drop in inflation.

“CPI inflation has eased sharply in May-June, relative to the prints of 3.9% and 3.0%, respectively, for March and April, which were available prior to the previous policy review,” said Aditi Nayar, Principal Economist, ICRA. “This sharper than expected fall in the CPI inflation is likely to have prompted the rate cut.”