This last statement is worth considering in some detail. It is probably best to declare at the outset that a case for cutting the policy repo rate remains ambiguous, if not weak, at the moment.
The June CPI data suggests that the inflation trajectory, very likely for FY15 and possibly for FY16, will falljustwithin the glide path envelope suggested by the Urjit Patel Committee and adopted formally as a de facto if soft inflation target. Some of the exogenous drivers underlying the previous inflationary environmentrural wages, fiscal programmes, labour supply responseslargely remain in place. The potency of others has diminished; minimum support prices of kharif crops have been recommended to be raised an average 1.5% in FY15, substantially less than in previous years. Vegetable prices, for instance, have not risen as much this rain deficient year as the previous normal year. Global commodities prices are expected to remain stable. Credit offtake remains very weak, with growth at 14% till mid-July, and Q1 capex data shows no signs of improvements in new and stalled projects.
But the risks to this presumption (and it is only that) are still very extant. The investment slowdown has probably diminished land acquisition payouts, but this might begin in the medium term once demand for land for new projects revives. Data on rural wages available till March 2014 show a surge in increases, although there is not a hint on what might be causing this; overall growth, even in rural areas. Price momentum, defined as smoothed month-on-month increases in the CPI index, has begun to tick up again. Gradually reviving growth is also likely to push urban wage rates up, before medium and longer term productivity increases begin to neutralise some of these raises. The rapid rise in equity valuations is likely to introduce wealth effects on consumption demand, and the search for land once investment starts might again revive a dormant driver of consumption. Indeed, signs of consumption demand have already begun to become evident, both in the early Q1FY14 results and certain consumer products.
The drive for fiscal consolidation remains encouraging, rationalisation of many administered prices continues, but there is still haziness about expenditure compression and crowding out to preserve a wait-and-watch stance. Raising administered prices will keep price pressures up (although this is a very positive outcome in the medium term). Combined with falling inflation, this might also incentivise financial savings, compressing the need for offshore capital, and keeping the current account deficit under check.
That said, the government seems to be experimenting with many micro market measures designed to increase systemic operational efficiency and, if rapidly implemented, will neutralise much of the increasing demand following higher growth.
Amidst all this, the prospect of sooner than expected Fed Funds Rate in early 2015 is likely to increase volatility in global markets, a brief preview of which we saw last week, after Q2-2014 US growth data and adequate jobs numbers. How Indian interest rates have (and will) track US yields is a story in itself, not carved in stone, but enough evidence exists of some co-movement which should make Indian policymakers careful, given the ostensibly increased exposure to volatile portfolio flows. Currency stability is a significant component of monetary policy, and near-term volatility disrupts the causal links between domestic policy rates and excess demand. (Please note the adjectives dotted around, each designed to emphasise the need for greater analytic clarity on cause and effect.)
Given all this, to come back to our earlier statement, the case for an accommodative stance remains blurred. This article mostly serves to lay out some of the multiple degrees of freedom embedded in taking a decision on monetary policy action. At the same time, if a rate cut is ever to be on the horizon in this economic cycle, it probably has to be now or in the very near future. RBI (reading its inflation fan chart) and almost all analysts seem to be on the same page on the likely trajectory of inflation in FY15, dipping to lows in November, before surging again till March (see chart).
That said, RBI has manifestly been trying to cut the cost of credit to selected sectors, facilitating the issue of lower cost long-term bonds for lending to infrastructure and affordable housing, (mostly) providing liquidity to banks to keep the short end of the yield curve close to the repo rate.
(Abhaysingh Chavan contributed to this article)
The author is senior vice-president & chief economist, Axis Bank.
Views are personal