While the action-stance-guidance interplay appears perplexing from the top, at the micro level, the same has been guided by evolving macro financial dynamics.
Rate cuts between January and April were driven by the combination of sharp drop in WPI inflation amid declining growth momentum and the governments resolve to stick to the path of fiscal consolidation.
So, what explained the accompanying hawkishness during January-April The answer lies in two different places. Optically, double-digit retail inflation and record high current account gap (information on current account deficit is available with a lag of one quarter) justified RBIs gradualist approach to monetary easing.
Strategically, the hawkishness nudged the government to take corrective actions on CAD (ranging from fuel price deregulation to hikes in gold import duty) including steps to ensure non-disruptive financing of the same.
What then explains Mondays status quo, accompanied by a balanced and cautious guidance Since the last policy review, WPI inflation momentum has weakened further. Additionally, momentum in core CPI inflation has started to show early signs of easing.
Greater comfort on the inflation front has not been accompanied by any concrete signs of a revival in growth momentum. This warranted a continuation in rate cutting. However, more than 7% depreciation in the rupee since last policy review in May and a deterioration of trade deficit over April-May vis--vis an expectation of an improvement managed to put a spanner in the works.
While the action on rates can be justified, the balanced and cautious guidance is a departure from previous policy reviews. This tacitly underscores RBIs greater willingness to ease in the months to come. Three factors will be crucial in translating this willingness into actions: Good monsoon performance will be crucial in lowering food price inflation. The performance so far has been extremely encouraging both in terms of quantum and distribution of rainfall. The government managed to positively surprise by delivering fiscal deficit of 4.9% of GDP in FY13 vis--vis the revised estimate of 5.2%.
Commitment towards fiscal consolidation by curbing wasteful expenditure (reflected in upward adjustment in fuel prices and staying away from rampant use of MSPs) would instill greater confidence towards adherence to fiscal consolidation and act to lower pressures on CAD from a long-term perspective. After increasing by more than 100% y-o-y during April-May, gold imports are expected to decline on the back of recent clampdown by policymakers. Moderation in gold imports will lower concerns on CAD.
Based on the current assessment of domestic scenarios, interest rates are likely to move lower by 50 bps. However, the change in RBIs stance/guidance signals that room for monetary easing will not get exhausted beyond this point. Further easing will remain on the table. All eyes are now on the FOMC meet later this week.