The arguments for monetary policy have always been the classic growth versus inflation debate. But this is pass today because we are no longer on this tradeoff as the belief is that low growth is not due to monetary considerations. The discussion board then moved to whether policy affects inflation. Here, too, the core inflation argument fell flat as it has not moved RBI, which still talks of generalised inflation. Logically, given that demand is low, we cannot be having excess demand forces anywhere. The debate then went on to the platform of which inflation rate we are talking of: WPI inflation or CPI inflation. In one of the earlier policies, RBI has emphasised that retail prices are more important as they affect us as consumers.
The portrait in front of us is quite clear. Growth is down or stagnant and there are few signs of it picking up in the near future as there is nothing much happening. Even if rates are lowered, actors will look to the Budget for direction and an entirely different set of issues will surface like GST, DTC, subsidy, etc. Inflation concepts present some ambivalence. WPI inflation is stable at around 7.2% while CPI inflation is high at 10.6%. This unfolds a conundrum for RBI because if it is looking at real interest rates, then it will find that when it adjusts the repo rate with WPI inflation, it is positive, while it is a big negative in case of the CPI. Therefore, RBI can toss the coin and be right either ways.
There are some compelling reasons beyond the clichd arguments centred on investment and growth for RBI to lower rates. The government has gotten its act together in the last few months with some positive announcements. While some have gone through, others are being debated. The FM has made the right sounds on controlling the deficit next year, and the progressive move on diesel price realignment is heartening. The economy has bottomed out and hopefully will not slide further. Under these conditions, lowering rates will help in creating the right expectations on monetary policy. A 25 bps cut may not be enough to stimulate the economy, which probably has already been buffered by the market, but it will provide some hope that RBI will not be too intransigent. Other rates may not come down, but still such a signal will be good for everyone.
The only strong case for RBI to hold on to its stance is that its target, i.e. inflation, still seems a tough nut to crack. After holding on to this belief for three years now, by lowering rates with unchanged inflation conditions, it would question this basic wisdom of not having done so earlier.
The market, on its part, always keeps hoping that RBI will act and lower interest rates with the belief being that market expectations are self-fulfilling. This is why it has almost been assumed that a 25 bps cut is on. Anything more would come as a surprise and spook the market upwards. This could be a turning point, though admittedly the probability is low.
The other aspect is the CRR. There is shortage of liquidity in the system though it has come under the 1% mark on January 24, which is just one working day before the policy announcement. Besides, RBI has resorted to open market operations in a big way to partly finance the funding requirement of the government borrowing programme, which obviates the need to go in for a CRR cut. Also it has been observed in the past that the CRR is less effective in getting banks to respond through rate cuts, as they are still influenced more by the repo rate than the CRR. Under these conditions, the CRR would remain unchanged this time.
The RBI action this time will be significant because it will give some sense about how RBI is going to behave going ahead this year. RBI has been talking of better fiscal management from the government and has stuck to its stance that interest rates are not solely responsible for low growth in the country. The FM has indicated that next years Budget will have a better fiscal number, though the number will finally be open to interpretation as there are differing views on the feasibility of a low fiscal deficit number given the harsh reality of low growth in an election year.
RBI will be tracking the inflation number too, which is higher on the food side rather than manufactured goods. The recent diesel price hike will add to inflation in a small, gradual way and hopefully get absorbed without spiking up prices.
Therefore, one can look forward to a 25 bps cut in interest rates, though it is uncertain whether this is a beginning of a chain of such moves, which will still be dependent on what happens on the 14th of every month when the WPI numbers come in.
The author is chief economist, CARE Ratings. Views are personal