Finmin cites fall in core inflation to make case for lower rates

Written by Sunny Verma | New Delhi | Updated: Jun 9 2012, 10:27am hrs
Ahead of the Reserve Bank of Indias (RBI) mid-quarter review of monetary policy on June 18, the finance ministry has pitched for a low interest rate regime in order to support faltering growth, while central bank officials have sent out mixed signals.

Economic affairs secretary R Gopalan on Thursday sought to build a strong case for an interest rate cut, citing the urgency of driving growth and the fall in core inflation. But RBI deputy governor KC Chakrabarty on Friday took a slightly different line, saying rates were not that high to significantly affect growth. Interestingly, Subir Gokarn, another deputy governor had said earlier this week that below-trend growth and falling crude oil prices offer the RBI a window to ease policy stance.

Gopalan said average annual headline inflation for the year is expected at 6.5-7%, even after taking into account the effect of the recent hike in petrol prices. Core inflation a key metric used by RBI in deciding policy rate has fallen below 5%, Gopalan said, indicating there is scope for reduction in interest rates.

The RBI cut its short-term lending rate or repo rate by a larger-than-expected 50 basis points in April. However, latest data showed GDP growth falling to a nine-year low of 5.3% in the fourth quarter of the last fiscal, far below expectations of the government as well as the central bank. Falling crude oil prices in the global market are providing an additional comfort, while the government announced a a 10% cut in the non-Plan expenditure.

The fine judgment is ultimately of the RBI, Gopalan added. Low inflation rate, easing of global crude oil prices, reasonable interest rates and containing fiscal deficit within the budget target of 5.1% would certainly provide the confidence to take growth forward, he said. Another senior finance ministry official, who did not wish to be named, said high interest rates were now adding to inflation, with corporates passing on the higher interest costs on to the customers.

Earlier, chief economic adviser Kaushik Basu had said that lower interest rates could actually help reduce inflation. After a gap of four years, China cut its benchmark lending and deposit rates by 25 basis points. Countries such as Brazil and Australia have recently lowered rates. Financial markets have already started factoring in rate cuts by the RBI, as reflected in falling yields in the government bond market.

A sharp fall in global oil prices, with Brent crude down over 25% from its highs seen over the past year, is adding to the expectations of a rate cut.

Commerce & industry minister Anand Sharma on Tuesday made a strong case for reduction in interest rates. I would urge them (RBI) to look at the present depressed investment climate and the disturbing numbers of fall in manufacturing core sectors and IIP (Index of Industrial Production) numbers.

Industrial output contracted 3.5% in March. Research firm Nomura expects a 25 bps cut in policy rates on June 18, and an additional 50 bps in 2012. Nomura sees a 20% probability of a 50 bps rate cut on June 18.

(For one,) the growth is somewhat lower than expectations and that may have a positive, moderating impact on core inflation. Two, oil prices have come off somewhat more than expected. Those are the two factors that suggest more room (for monetary policy), Gokarn had said. Indias GDP growth had slumped to a nine-year low of 6.5% in 2011-12 due to the steep fall in manufacturing growth and a contraction in mining output among other factors.