Home / Opinion / Online-views /  RBI can’t deny rate cuts for long

The Reserve Bank of India’s (RBI) strong anti-inflation rhetoric, after it decided to hold policy rates steady in June, has led to a toning down of expectations from the monetary policy review in July. To an extent, the markets have moderated their expectations of monetary easing over the remaining months of FY2013 as well. I, however, feel that given the widespread weakness in the economy, internally RBI must be in a far bigger dilemma than what recent public statements suggest. As such, the upcoming policy decision remains in fine balance and I still maintain a bias towards a 25 basis points (bps) repo rate cut in July. Markedly sub-par growth, softening core inflationary pressures, near-zero fiscal spending headroom, and what are likely be only hesitant government policy initiatives to revive the economy underscore the need for greater monetary accommodation in coming months. I pencil in a cumulative 150 bps repo rate cut in 2012-13 (including the 50 bps cut in April).

Bad monsoon to hurt growth far more this year

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Amid marked weakness in exports and investments, consumption remains key for the economy in 2012-13. But the detrimental impact of a bad monsoon on consumption, and subsequently on overall growth, can potentially be far greater this time than in the recent past (eg. 2009-10). At that time, India enjoyed exceptionally easy monetary conditions, better global growth, lower commodity prices and considerably better domestic sentiment. In addition, the government managed to provide sizeable fiscal support, especially to rural India, such as rural employment support, higher prices for crops, salary hikes in the government sector, and cuts in excise and service tax rates. A slippage in consumption demand due to bad monsoon would, thus, imply sizeable downside risks to the already weak growth scenario.

Softer core inflation the key positive

Headline inflation is unlikely to soften quickly, especially with upside risks due to fuel price hikes and/or higher food inflation. Core inflation, which excludes food and fuel, is, however, set to soften further in the second half of 2012-13. Demand for several key components that drive core inflation (eg. textiles, metals, chemicals, industrial equipment) remains somber at the moment. The spill-over of higher fuel and food inflation, unless dramatic, onto core inflation will likely be smaller now given poor industrial demand and weaker pricing power. Thus, while potentially higher food inflation will still be a worrying factor for RBI, fuel price-led inflation should be seen mostly as a statistical phenomenon. Moreover, a fuel price hike would be a somewhat restraining factor for the economy apart from helping fiscal consolidation at the margin. Chances of rate cuts, thus, will rise if the government is able to marshal the political determination to hike fuel prices.

Shifting focus across different inflation indicators not preferable

Future guidance on monetary policy would be as important as the rate action in July. Of late, RBI seems to have often shifted focus among different inflation indicators (eg. headline, core, consumer price and core-consumer price inflation). Trends in these different measures have often been divergent, leading to a considerable rise in policy uncertainty. It will be very useful if RBI can provide even an indicating pecking order of these different inflation measures. Such guidance will potentially impose even greater discipline and objectivity in RBI’s policy formulation and will help in significantly enhancing consistency and credibility of monetary policy.

Siddhartha Sanyal is chief India economist Barclays Capital.

(The Reserve Bank of India will announce its first quarter monetary policy review for fiscal 2013 on 31 July. This is fourth in a series of articles by eminent economists on what to expect from the policy.)Next: Ajit Ranade, chief economist, Aditya Birla Group.

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