Core inflation must fall to trigger rate cuts: Chakrabarty

Written by fe Bureau | New Delhi | Updated: Nov 22 2012, 08:07am hrs
Reserve Bank of India deputy governor KC Chakrabarty on Wednesday said manufacturers must rein in prices of their products to ensure headline inflation comes down to 4-5%, which is the main pre-requisite for triggering rate cuts.

The twin problems of high fiscal and current account deficits were also coming in the way of lowering policy interest rates, strengthening rupee and fostering growth, he said at an Assocham banking conference here.

While "explosive growth" of 8-10% is desired for the next 20 years, he said factory capacity must be expanded to sustain such growth. Otherwise, it creates over-heating in the economy and fuels inflation. The moment growth passes 8%, we have inflation. We must create capacity, he said urging industry captains to invest more for capacity expansion.

India's gross domestic product expanded by 5.5% in Apr-Jun, tad higher than 5.3% in the previous quarter but significantly lower than 6.5% recorded for the entire 2011-12 as global economic crisis coupled with policy paralysis at the government and high borrowing costs stalled investment.

Unlike the quick response to the 2008 crisis, the government could not roll out stimulus by way of higher spending and tax cuts as it was hamstrung by a high deficit of 5.8% in 2011-12, while near double-digit inflation prevented RBI to cut rates aggressively.

After cutting policy rates by 50 basis points in April, RBI paused on rates in the subsequent policy reviews citing high inflation and government's budget deficit. Though the central bank offered some relief by paring cash reserve ratio by 50 bps in two steps and cutting statutory liquidity ratio by 100 bps, industry is demanding rate cuts to prop up investment and growth.

(Rate cuts) will not come automatically unless inflation is low, Chakrabarty said virtually ruling out rate cuts in near future.

Global food prices are under pressure. So I don't see agriculture inflation coming down. So, for headline inflation to come down to 4-5%, the core inflation has to come down sharply, he explained.

India's headline inflation rate declined to 8-month low of 7.45% in October as rupee appreciation helped lower prices of imported manufactured goods and edible oil. While food inflation stayed at 6.6%, the manufacturing inflation was at 5.95%.

Chakrabarty said the core or non-food manufacturing inflation should come down to 1%. This can happen if manufacturers improve productivity through use of technology as it has happened in textile and telecom sectors.

Instead of RBI having to cut rates, he asked banks to lower lending rates by lowering cost of borrowing, leveraging technology to cut operational costs and cutting non-performing assets which has climbed to 5% of loan advances.

While calling for austerity measures not only at the government but also in corporate to cut wasteful spending, Chakrabarty said the country cannot achieve higher growth without improving governance at all levels.