Home / Market / Mark-to-market /  Retail inflation moves past RBI target. Is a rate cut coming?

When an emerging market economy’s inflation rate comes perilously close to that of an advanced economy, it is time to sit up and take notice. India’s retail inflation slipped to 2.2% in December, a number that was until November the retail inflation of the US.

A fast-growing emerging economy like India can ill-afford such a low inflation rate. If high inflation acts as a threat to growth, ultra-low inflation does the same. It is no surprise that this low inflation is symptomatic of the agrarian crisis, wherein rural wages are stagnating and earnings have collapsed for many farmers. Growth brings income and a collapse in inflation will threaten to erase the incentive to produce.

Another outcome of the falling headline inflation is high real effective interest rates. If one takes the one-year treasury bill yield of 6.83%, the real interest rate works out to a whopping 4.64%. Economists believe such high rates do not inspire future investments. Shubhada Rao, chief economist at Yes Bank Ltd, believes the latest inflation numbers should trigger a debate among monetary policy committee (MPC) members and a rate cut should be a logical outcome.

“Given the near-term inflation trajectory and lower probability of negative shocks amid moderating global growth, a rate cut now could spur growth and address the issue of high real interest rate hampering investment activity. Ergo, should the need arise, going forward, for the Reserve Bank of India (RBI) to tighten, given global uncertainties, it can go ahead without serious implications on growth," added Rao.

That said, most economists believe that MPC will change the monetary policy stance back to neutral in February, but a rate cut could be pushed to April. “MPC will probably change its stance back to neutral at the February meeting. However, rate cuts will depend on multiple factors, such as expectations of crude prices, the possibility of fiscal slippage, particularly for states, the US Fed guidance and the extent of domestic growth weakness," said Saugata Bhattacharya, chief economist at Axis Bank Ltd.

Another reason that may stop the MPC from voting for a rate cut is the stubborn core inflation, which excludes food and fuel, that hovers around 5.5%.

December inflation shows that a supply glut destroyed food prices, but services continue to get expensive as more Indians access healthcare and education. Healthcare inflation was 9%, while education inflation rose 8.3%.

For RBI, which has an inflation target of 4%, the December inflation gives enough fodder to consider a rate cut. But the road to lower policy rates is paved with global uncertainties and the unbending core inflation.

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