Most of the price pressures, it was argued, were out of supply side considerations and the RBIs rate hiking cycle, anyway, has failed to kill the inflation dragon, while depressing the growth dynamics.
Therefore, calls of market participants were for a repo cut or a CRR cut, or even both. However, RBI did not bow to these pressures and left both the CRR and the repo rate unchanged. Its communiqu very objectively argued that the RBI had front-loaded its policy rate action in April with the 50 bps cut. And, todays action also very categorically established the independence of the RBI.
For the RBI, the risks to the economy continue to be from an elevated level of inflation and, more importantly, the persistence of risks for future inflation. While, in the recent past, the RBI did talk of some elbowroom being created out of a drop in the global oil prices, todays statement highlights the likelihood of more liquidity infusion by central banks in advanced economies in the near future that could lead to a possible rebound in the global commodity prices.
Further, the rupee depreciation effect has indeed significantly killed off any positives on inflation that could have been derived out of a drop in the global commodity prices, including crude oil. The essence: moderation in the wholesale price inflation has not translated into the retail level. Further, moderation in core inflation, along with persistence of high overall inflation at both wholesale and retail levels, indicates the presence of supply-side bottlenecks and sticky inflation expectations.
The RBI clearly points to the strong distorting price signals that the absence of pass-through on domestic oil prices entail, thereby preventing any downward adjustment in aggregate demand.
Conversely, on the growth side, the take from the RBI is that it finds little impact of the interest rate cycle on growth. Especially, says RBI, real effective bank lending interest rate remained lower in the recent past compared to the levels seen in 2003-08, the high growth phase.
This implies that the borrowing costs were not the only cause for the investment slowdown.
What can we expect going forward My opinion is that in terms of evaluation of risks, we are likely to see the least priority to be assigned to growth on a continual basis.
The bigger concern for the RBI is likely to inflation, the exchange rate and the need to maintain financial stability in the domestic environment. Given that the risks panning out from the global financial markets continue to be significant, an adequate amount of firepower needs to be maintained with the RBI to fight any Lehman-like crisis situation. Thus, going ahead, with the CRR already down to 4.75%, the room for cut here could also be limited. In this context, OMO could be the favoured instrument to manage liquidity deficiencies at the margin.
We still do expect the RBI to cut repo rate by an incremental 50 bps and the CRR by 100 bps in FY2013.
However, these could be heavily conditioned by news and events from the global arena. Thus, assuming that there is no further increase in global risk-aversion immediately, my estimate of the growth-inflation dynamics does not allow me to foresee a rate action in the next policy meeting on July 31.
The writer is chief economist, Kotak Mahindra Bank. Views expressed are personal