Column : Surprise with a deep monetary policy easing

Written by Saugata Bhattacharya | Updated: Jan 29 2013, 05:51am hrs
The Macro Development Report reiterates that the balance of macroeconomic risks suggest continuation of the calibrated stance while increasingly focusing on growth risks. Translated, RBI will probably cut the repo rate by 25 basis point today. But there is a significant case for deeper cuts. Deeper cuts Any economic analyst advocating deep monetary policy easing action when at least one of several inflation indicators is flashing red must surely be blinkered on basic central banking principles. But let us lay out the case for this.

First, despite a series of price rationalisations that have reduced the degree of suppressed inflation, the WPI inflation trajectory is firmly lower than earlier projections, and current projections indicate that it is likely to drop below 7% by March 2013, below the 7.5% projected by RBI in October. Remember, that the September 2012 diesel price hike was likely to have added about 7 points to the fuel sub-index of the WPI, and 1.5 points to the headline WPI, but there were negligible second rounds effects in October, contrary to expectations. Core (i.e. non-food manufacturing inflation) is down to 4.2% (and looking to drop further in the next 9 months).

Then, there is the trajectory of WPI inflation, which was earlier expected to peak in December, but which now appears to have topped out in September. On a downward trajectory, it is unlikely that there will be major revisions in the provisional index numbers. If things go according to plan, the rupee is likely to strengthen, which will further tamp down inflation. Money and liquidity indicators are weaker than projected by RBI.

But despite all this, consumer price inflation still remains close to 11%. Some part of the persisting high food price inflation (food is 50% of the combined food basket of the CPI) is due to a base effect of low to negative food inflation in December and January a year ago. Constraints on production of protein items like poultry, eggs, milk, etc, due to electricity shortages in key producing states adds to the problem. But the underlying drivers for this broad-based increase are still in place. Rural wages are still increasing at 17% (although down from 23% a few months ago), a phenomenon that is only partially explainable, despite MSP of rice having increased by 16% in 2012 (other government subventions have stabilised or reduced).

The manifest concern with all this is the effect of a wage-price spiral, transmitted inter alia through CPI indexed DA increases. Allowances of central government employees alone were a budgeted R53,000 crore in FY13. A 10% increase might add another R5,000 crore to demand.

While undoubtedly a concern, the evidence on the ground of sustained aggregate demand appears increasingly muted. Early corporate financial results (based on a sample of 189 non-financial, non-petroleum companies) show that sales are slipping, down to 11% year-on-year from 15% in the previous quarter. Of the sample companies, manufacturing segment growth is down to 9%, and service companies down very sharply to 17% from 26% in the earlier quarter.

The results of Hindustan Unilever, the bellwether consumer goods company, provide more pointers to a demand slowdown. Volume growth slowed to 5% year-on-year, due to weak sales in personal care and foods segment, which are the most discretionary consumer spend segments. Even in durables, car sales have remained weak, with the apex industry body having forecast FY13 growth at 0-2%, the lowest in many years. In modern trade (large format retail stores), net store closures are being reported and new store expansion has slowed considerably.

On balance, the macroeconomic imbalances look much better than at the time of the second quarter review at end October, considering the risk factors emphasised by RBI. The inflation trajectory is lower than expected, despite an increase in many of the erstwhile controlled prices.

At the same time, growth indicators continue downwards, and will weaken further if the government follows through with fiscal consolidation, of which there is every indication, impacting consumption. This lower pre-emption might enable increased private sector investment, if institutions like the Cabinet Committee on Investments are cleared and other processes expedited. A calibrated stance might indicate that, as the macro imbalances improve, monetary policy might be expected to coordinate in gradual steps in enabling a reduction in cost of funds to boost the capex cycle.

The author is senior vice-president, business & economic research, Axis Bank. Views are personal