Column: Has the rate cycle peaked?

Mar 27 2014, 22:22 IST
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SummaryA rate-cut decision will boil down to the prospects of inflation following the glide path into 2016 and thereafter

There seems to be wide consensus that RBI will remain on hold at the next monetary policy review meeting on April 1. This view is consistent with the forward guidance in the last policy statement, with CPI inflation having come off over the past couple of months and likely to track (albeit in a bumpy manner) the announced glide path, coming close to the announced way-point of 8% at January 2015 (the accompanying chart shows inflation track in 2014 under different scenarios). However, given the evident central banking antipathy to persisting price pressures, the expectation of core CPI inflation (as well as the core part of the now-low priority WPI inflation) creeping up might induce a surprise pre-emptive hike in rates in the attempt to add another anchor to inflation expectations.

That, however, is not the purpose of this article. Assuming status quo this time, how might the policy rate move in 2014, extending into 2016? Analyst expectations seem divided on rate hikes or cuts in the future, with polls seemingly split equally into ‘hold’, ‘raise’ and ‘cut’. Our own thinking is that we might not get a rate cut for the next economic and credit cycle, unless the drivers of inflation become so benign that both the trajectory and expectations suggest a sustained movement down the glide path, to 6% by January 2016.

The problem is that we are currently in a very state-contingent environment, with some clarity likely to emerge only in the next 2 to 3 months. A favourable configuration with a

stable government at the Centre,

normal rains and global recovery will result in outcomes very different from the alternative of a fractured mandate, political uncertainty,

deficient rains and consequent currency and foreign capital flow volatility. Is there a case for a rate cut in either case? The balance of probability seems to suggest not.

In the event of a stable coalition at the Centre, growth supportive measures will be put in place rapidly. Not that growth will move up quickly, probably inching up in the initial year to around 5.5% and then gradually rising to over 7% as capex kicks in. The problem is that will inevitably push up core inflation not just for manufacturing but for many services as well, as corporates, eager to expand beaten-down operating and profit margins, begin to use their improving pricing power (as is already being seen in the

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