Why the RBI held interest rates (the dog that didn’t bark)

On Friday, the RBI surprised our financial markets by holding the interest rate structure.

There was a broad-based consensus that the Monetary Policy Committee (MPC) of the RBI would raise rates by 0.25% (25 bps). Some market watchers predicted a steeper hike, of 0.5%. Less than 20 % of economists surveyed before the MPC meet thought it would vote to hold rates. Yet, the committee took that decision, by an overwhelming majority of 5:1.

My effort here is not to opine whether the MPC took the right decision or not; both on the committee, and outside, there are highly qualified economists, armed with massive data sets, who do this kind of analysis full-time. I am, instead intrigued by how there can be such a sharp divide between economists on the panel, and those outside – 82% on the outside for a hike; 83% on the inside against it. Polar opposites.

Why would this have happened?

At this point, I can think of only one reason – the economists on the inside have access to data that those on the outside don’t have.

This cannot be about external conditions, which occupy so much of the economic news today – oil prices on the boil; our widening foreign exchange gap; the sliding rupee; surging interest rates in the US; reverse fund flow from emerging markets to global financial centres.

It can only be about Indian data sets. Our public data shows India is growing at 8.2% per annum. If this were the case, since imported inflation is a threat, it would make sense to raise interest rates pre-emptively. But supposing the economy is NOT growing at 8%, and domestic demand is under threat, then it might just make sense to hold back an interest rate hike.

Economy-watchers know that the new GDP series has several inconsistencies, but are not equipped with the data to understand exactly how wrong it is; the RBI, on the other hand, has much more insight into the current state of the economy, and the risks to growth.

To my mind, the RBI’s concern about the fragility of the Indian economy is the most logical explanation for its surprise decision to hold back a rate hike.

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