The first monetary policy of the fiscal year has often sprung a surprise in the past. In the first monetary policy of FY2012, the Reserve Bank of India (RBI) had raised the repo rate by 50 basis points (bps) and in FY2013, it had reduced the policy rate by 50 bps. One basis point is 0.01%.
The contradictions in macro data (low growth-high inflation, low growth-high current account deficit) seems to have come down in the recent past, paving the way for further monetary policy easing. But, will RBI maintain the tradition of surprises in the first monetary policy of the fiscal year and cut the policy rates by 50 bps on 3 May to give growth a shock therapy? It is probably worth pondering on that question.
At the end of FY2013, wholesale-price inflation at less than 6% and core inflation around 3.5% were clearly positive surprises for the market. This has happened even before the commodity price meltdown in April and, hence, a further decline cannot be ruled out. Falling inflation clearly reflects the declining pricing power of companies. Consumption growth has definitely moderated and even the second round effect of the fuel price increases through higher transportation costs have not been felt on the overall wholesale-price index (WPI). In fact, monthly fuel consumption data show that for most of the items (particularly diesel), volume growth has finally turned negative. Higher fuel prices might also be taking its toll on other consumer items.
RBI has consistently been hoping for such lower subsidy induced demand moderation. So, the central bank can finally breathe a little easy on inflation.
With little signs of a growth recovery and unexpected fall in inflation, the thought of a 50 bps repo rate cut might have crossed RBI’s mind. However, delivering a 50 bps rate cut might not be that easy. First, RBI has always maintained that capex recovery is less dependent on interest rates in the current context. Lack of policy clarity and procedural bottlenecks have been bigger hurdles. Would the recent decisions by the Cabinet Committee on Investments convince RBI that there has been a material change in the government’s approach towards promoting investment?
The second factor would be the WPI-CPI (consumer-price index) conundrum. Although there is no particular reason why these two indices should be moving in tandem (in fact, it could well be that the CPI lags WPI), a double-digit CPI inflation limits the scope for monetary easing. This could be a major constraint to cut rates by 50 bps since the credibility of monetary authorities will be at stake. Putting too much emphasis on CPI is difficult given that we do not have a long history for this series, but at the same time, it cannot be ignored altogether.
Third, it will be difficult for RBI to extrapolate the recent commodity price decline. We have seen such price corrections in the past followed by a surge again. If growth in China picks up in the latter part of the year, the commodity price correction could well be short-lived. This will not only take the sheen out of the further easing of inflation but also keep the current account deficit concerns alive.
Last but not the least would be the constraint imposed by RBI’s guidance given in the March policy. It had mentioned that the scope of monetary easing is extremely limited. Although the incoming data flow has been more positive after that, a 50 bps rate cut might still contradict that guidance. So, RBI is more likely to deliver a combination of a 25 bps rate cut and a softer guidance, leaving the room open for more easing if the commodity price decline sustains. Liquidity enhancing measures will be kept on hold with improving liquidity. Caution will still be the core of this policy rather than a radical stance.
This is the third in a series of five articles by economists ahead of the Reserve Bank of India’s annual monetary policy review on 3 May.
Next: Richard Illey, chief economist, Asia, BNP Paribas SA.