The backdrop to the Reserve Bank of India (RBI) monetary policy meeting next week is not very different from what it has been in the recent past. Inflation is clearly at an unacceptable level and growth is moderating, but not collapsing. So, it is quite likely that the policy response from RBI will be a 25 basis points rate increase to reiterate its anti-inflationary stance. However, there is considerable uncertainty over the policy trajectory going forward and hence the policy statement will be scrutinized closely for RBI’s assessment of the current economic situation and any forward looking cues.
Before we make forecasts about the policy trajectory, it is important to have a quick look through the rear-view mirror. We believe that the annual policy announced in May brought a change to RBI’s way of looking at monetary policy setting. It was explicitly acknowledged that in the near term, we might have to sacrifice some growth to tackle inflation. In line with that, a so-called calibrated soft landing policy was adopted to avoid the possibility of sustained high inflation hampering long-term growth potential.
The general expectation is that the policy rates will be tightened till either inflation starts coming off or growth becomes too “soft”.
Inflation in FY12 (fiscal 2012) has been in line with RBI’s projection even after the recent fuel price revisions. The headline WPI (Wholesale Price Index-based inflation) has been quite flat in the 9.4-9.75% range for the last seven months and we think that the 9-10% range on inflation is likely to continue till at least October. Even on RBI’s preferred measure of non-food manufacturing inflation, there is no flare-up in the last three months. What will further comfort RBI is that the seasonally adjusted month-over-month inflation readings (which better indicates the momentum in prices) have been declining over the same period. Overall, we think that inflation is likely to remain a cause for concern, but the absence of negative surprises should soothe some nerves and keep inflation expectations under check.
Inflation uncertainties now stem from three sources— renewed pressure from global commodity prices (particularly oil, oilseeds, edible oil, sugar and metals), a truant monsoon and larger-than-expected pass-through of higher fuel prices on to other commodities. Monetary policy is likely to have limited success in controlling inflation arising out of any of these events. However, in case of these price shocks, inflation could be more protracted, making it difficult for RBI to lower its guard.
The outlook on growth is more uncertain. The industrial production data is trending downwards, specifically in the intermediate and capital goods sectors. However, one is not sure whether robust conclusions can be drawn from this data, which has been volatile and subject to significant revision. Other proxy indicators such as credit growth and non-oil import growth have also moderated, but still hover around healthy levels. On the other hand, business confidence is at a low and new projects in the pipeline are sparse on the back of rising rates, policy inaction and global uncertainties.
RBI in any case has this difficult problem of deciding how much of a near-term growth sacrifice is acceptable. Lack of consensus in growth indicators compounds that problem. Also, further policy action should take into account the lagged effect of the cumulative rate increases and should not choke the supply side completely. Our baseline view is of one more rate increase after the July policy because inflation sustaining above 9% will still keep the real policy rates negative and force RBI to maintain the bias towards inflation management. Disorderly global developments and a declining trend in core inflation might force the central bank to rethink a rate increase post July, which remains a risk to our view.
Samiran Chakraborty is Asia economist, Standard Chartered Bank. These are his personal views
On 26 July, the Reserve Bank of India will announce its quarterly review of monetary policy. Will it continue to tighten the policy with yet another rate hike to fight high inflation or will it press the pause button as growth is being threatened? This is the last in a series that Mint has been carrying in the run-up to the policy.