Will RBI cut its policy rate in its forthcoming policy statement? Opinions are surprisingly divided despite the sharp fall in inflation. During the middle of this month, inflation data covering the Consumer Price Index (retail inflation) and the Wholsale Price Index (wholesale inflation) for October were released. The most significant point is that inflation under both heads has fallen sharply.
Retail inflation at 5.5 per cent was almost one percentage point below that recorded in the previous month. It is also the lowest since the index was created.
Over the past several years, it has been the rise in food prices (food inflation) that has been underpinning overall inflation.
Therefore, there is some significance attached to the fact that the rate of food inflation at 5.6 per cent is almost the same as that of retail inflation. This has rarely happened before and suggests that food prices are cooling. Analysing the trends among the individual components of the Consumer Price Index, milk and fruits continue to exert pressure, the rise in their prices being 11 per cent and 17 per cent, respectively. However, cereals and vegetables, which have been driving up the overall index, are somewhat subdued at 6 per cent and 1.5 per cent, respectively.
Deft handling
One broad inference from the above is that the much feared threat from insufficient monsoons has not materialised. It is also liked that the NDA government’s deft handling of inflation — through open market sales of rice — has helped.
Also, the new government has not been encouraging States to pay a bonus over and above the minimum support prices (MSPs). Clearly, the NDA government is aiming to reorient the signalling mechanism of the MSPs to crops other than staples. The open market sale, which is likely to continue, can make a big dent on insignificant expectations.
Although the southwest monsoon recovered, albeit belatedly, farmers probably went in for short duration crops such as vegetables.
Though induced by nature, the shift towards vegetables is a welcome development, and ought to be encouraged by building robust supply chains and refrigeration facilities.
The WPI has ceased to be the anchor for monetary policy purposes. Nevertheless, its significance to policymaking is large. There are a different set of factors behind the WPI compared to the CPI. Prices of manufactured goods rose by about 2.4 per cent over October, 2013. The comparable rate was 2.8 per cent last year. The rather modest increase in manufactured goods inflation would seem to suggest that producers have at least temporarily lost their pricing power. However, falling commodity prices will impact favourably on manufacturer’s balance sheets by widening their operating margins. That in turn should pave the way for an investment revival.
Falling petroleum and other commodity prices are obviously good for the macroeconomy. The current account deficit should narrow, and the fiscal deficit will reduce. And now the most important question of the day is how does the falling inflation impact the forthcoming monetary statement? Will the RBI cut the policy rates on December 2? Not just the usual parties — chambers of commerce and industry organisations — but even the Finance Minister has joined in the chorus. The Finance Minister’s statement is particularly significant. Unlike his predecessor, P. Chidambaram, Arun Jaitley has only rarely expressed, at least in public, his preference for a softer monetary policy stance.
Going by the steep decline in inflation alone, the case for a rate cut in the ensuing policy statement looks obvious. The RBI’s target range for inflation — 6 per cent by January, 2015 — has been achieved. Although there are some early signs of growth, a full blown recovery seems far off. A rate cut would be a stimulant.
Ranged against such seemingly incontestable points are a few but strong voices that advocate status quo in the policy stance at least for now. Some of those arguments are familiar: that interest costs are a small part of the total manufacturing costs; and a reduction in the repo rate will hardly make an impact. Despite abundant liquidity, banks have not been lending enough mainly because there is as yet no real pick up in the industrial sector.
The weighty argument
Then there is the weighty argument that depositors’ interests are not protected. A repo rate cut may force banks to not only reduce their lending rates — the intended outcome — but also their deposit rates. Already depositors as a class lack clout, and are in no position to influence monetary policy.
With the fall in inflation, some of them are on the cusp of getting a real return but such hopes will be dashed if deposit rates are to fall further.
Many of them may switch to physical assets from financial savings and that will not be good for the macroeconomy. India’s external sector may be comfortable now. The rupee is stable, and the expected flight of portfolio investment in the wake of the U.S. Federal Reserve terminating its ultra soft policies has not materialised. Yet, external sector stability cannot be taken for granted.
Sometime next year, U.S. interest rates will go up, and that would be a trying time for authorities here to proactively prevent an exodus.
Finally, oil and commodity prices may not always remain at the current low levels. In fact, there is a fear that they may reverse.
In any case, the war against inflation cannot be toned down on assumptions of commodity prices remaining soft for a fairly long period. Come December, therefore, there will be a large number expecting or at least hoping for a rate cut. But, an influential smaller number’s view — a no change stance — may still prevail.
