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Business News/ Opinion / Online Views/  RBI may take a calculated risk and ease monetary levers
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RBI may take a calculated risk and ease monetary levers

The central bank may choose to ease policy within the headroom it has and cut repo rate by 25 bps

RBI can draw some comfort that monetary easing globally is not having an adverse impact on the Indian economy via imported inflation. Photo: Mint (Mint)Premium
RBI can draw some comfort that monetary easing globally is not having an adverse impact on the Indian economy via imported inflation. Photo: Mint
(Mint)

Going into the half yearly review of the monetary policy for the current fiscal year, the Reserve Bank of India (RBI) is faced with a macroeconomic environment characterized by high and rising benchmark wholesale inflation, stabilizing growth momentum with signs that economic activity has bottomed, a stable-yet-weak currency, easing commodity prices and slowing global growth. While this macroeconomic backdrop has largely been in place over recent policy reviews, there is a key difference this time around. Policy activism by the government since mid-September has, to some extent, eased the constraint the environment of policy stasis had imposed on RBI, prompting it to maintain a tight handle on monetary levers.

Revival of the monsoon and a moderately stronger rupee are the other significant developments ahead of this policy review. These, combined with the government’s efforts towards fiscal consolidation by curbing fuel subsidies, attracting stable foreign capital flows and measures to address the supply side bottlenecks in crucial sectors such as power, bode well for a recovery, particularly in investment activity.

The first round of these policy reforms were announced ahead of the quarterly policy review in September and RBI chose to ease liquidity by cutting the cash reserve ratio (CRR) to 4.5%, mainly in anticipation of seasonal liquidity tightness. The case for further monetary easing is tenuous, especially as RBI remains committed to curbing inflation, which remains sticky and higher than its target. The headline WPI (wholesale price index) currently at 7.8% is likely to rise to 8-8.5% in the next couple of months, as favourable statistical base effect fades and recent fuel price hikes add to the seasonal inflationary pressures in food prices during the third quarter. Consumer price inflation, too, remains near double-digit levels.

Core WPI inflation, however, could stabilize in the range of 5–5.4% compared with 5.56% in September. Weak pricing power for manufacturers, combined with a stronger rupee, would help keep a lid on core inflation. RBI could also draw some comfort that monetary easing globally is not having an adverse impact on the Indian economy via imported inflation.

Global commodity prices, particularly that of crude oil, have remained stable despite another round of liquidity infusion by major global central banks led by the US Federal Reserve. Weakening prospects of the global economy, as projected by the IMF (International Monetary Fund) recently with Europe in recession and China slowing down for seven successive quarters now, has countered the upward pressure on commodity prices created by easier monetary conditions. In fact, second quarter corporate results point towards easing input and raw material costs, reflecting stable commodity prices globally.

While higher inflation will remain the main constraining factor for RBI in providing any monetary stimulus, growth falling well below its trend rate (7-7.5%) is unlikely to be ignored completely. This is especially considering that the global economy is going through a period of a slowdown which can prolong well past 2013. In this policy review, RBI is likely to lower its assessment of GDP (gross domestic product) growth to closer to 6% than 6.5% now. The consensus forecast for real GDP growth this fiscal year is below 6%. The recent spate of measures would only help in a recovery over the medium term, provided that the global economic and capital market environments also improve.

Therefore, some consideration to help revive growth and to complement the government’s policy measures may see RBI take a calculated risk and ease monetary policy within the limited headroom it has. After having used liquidity tools (statutory liquidity ratio and CRR) to ease monetary levers so far this year, RBI may choose to cut the repo rate by 25 basis points (bps) on 30 October. This will not dilute its focus on inflation given the tight liquidity conditions prevailing in the banking system. At the same time, it would buttress the steps taken by the government to facilitate an economic recovery. The alternative is, of course, a 25 bps cut in CRR, which would inject about 17,000 crore into the banking system, but may not necessarily help in easing rates in the economy. It is perhaps time for RBI to indeed take a calculated risk.

(The author is senior economist, Royal Bank of Scotland N.V. This is the third in a series of five articles ahead of the Reserve Bank of India’s second quarter monetary policy review on 30 October.)

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Published: 24 Oct 2012, 06:44 PM IST
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