RBI?s move of keeping the repo rate unchanged indicates the central bank continues to accord importance to price stability over growth. In September policy, RBI welcomed the government?s initiatives to contain fiscal deficit and address policy bottlenecks. Also, it cut CRR by 25 basis points to prevent tight liquidity from coming in the way of GDP growth, which it now sees slipping to 5.8% from its earlier projection of 6.5% for 2012-13.
Monetary policy needs support of fiscal discipline to curtail inflation. With that support now beginning to come from the fiscal consolidation programme and reforms announced by the government, the conditions for a rate cut are becoming conducive. And RBI has already hinted at a repo rate cut early next year, when conditions are expected to be favourable. For now, however, RBI has decided to limit its monetary easing to the CRR cut, as current data on inflation does not give much comfort.
Unquestionably, Indian economy?s growth potential has been eroded by slowing investments as well as policy bottlenecks, but current growth is even below India?s re-estimated growth potential of around 7%. Private consumption growth too fell to a decadal low of 4% in the second quarter of 2012-13 and capacity utilisation is declining. In such a scenario, demand pressures on inflation should be anemic at best. But surprisingly, core (non-food manufacturing) inflation continues to hover above comfort level at 5.6%. This implies rising costs ? particularly that of imported inputs, due to depreciation ? are still getting passed onto final goods.
Good news is that food inflation, despite weak and uneven monsoon, is easing. However, its impact has been negated by rising fuel inflation and currency depreciation. As a result, WPI inflation stood at 7.8% in September and is expected to rise further in the coming months, as recent fuel and electricity price increase get factored in WPI data. CPI inflation is close to double digits. Consequently, inflationary expectations continue to remain elevated at this juncture.
Although the rupee has strengthened somewhat, inflation faces risk of upward pressure from international commodity prices. Global commodity price movements need to be carefully monitored as upside risks from quantitative easing in the US persist. Further, geopolitical risks, which can push up crude prices, are very much prevalent in the West Asia. Rural wages continue to rise and the consequent rise in demand for food items has the potential to compound price pressures due to supply-side weakness, as has been the case in the past few years.
RBI?s target of around 5% inflation has remained elusive in the last few years. If RBI attempts to achieve this target through a tight monetary policy, we may have to sacrifice growth. To effect a durable reduction in inflation, besides a reduction in the overall fiscal deficit, the government?s expenditure mix too must shift focus from consumption towards investment to improve supplies. As this happens, high inflation and uncertainty on the interest rate front will recede. We expect a 50 bps cut in repo rate by March 2012.
Writer is chief economist, Crisil