The risk to inflation from global crude oil prices that the central bank had flagged in October has now reduced in a big way. Despite the rally on Monday, oil prices are down a whopping 26% since the October meeting.
There is enough evidence to say that rural income hasn’t risen and hence demand pressure from there is unlikely to manifest. Even the weak rupee has recouped its losses, cutting the pressure on the import bill and hence domestic inflation.
Indeed, RBI has less reason now to hike interest rates than it did two months ago when it chose not to hike. The central bank’s decision is based on its assessment on the future of inflation and inflationary expectations, not just past data. Its previous survey had shown an increase in households’ expectation of inflation three months ahead. One reason could be the sharp rise in core inflation. Core inflation was an uncomfortable 6.1% in October.
For now, the benign economic data may warrant a vote to keep rates on hold; but how RBI would turn on rates in the next meeting will depend on the government.
The Union Budget will be announced on 1 February and it will provide a clearer sense of where the year’s deficit is likely to end up. The central bank’s policy rate move will depend on how much the government is able to stick to its fiscal discipline and the impact of the surrounding elections on inflation. Given that the government’s historic trend in sticking to targets does not inspire much confidence, RBI may well move on its calibrated tightening sooner than later.
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