RBI finally says yes, but forward guidance remains cautious

Written by Indranil Pan | Updated: Jan 30 2013, 07:59am hrs
It must have been another tough call for RBI, but it is heartening to note the tilt now is more towards growth than inflation. In terms of RBIs own mindset, the risks to inflation ballooning once more are limited. No wonder, RBI brought down its own inflation projection to 6.8% for March end compared with the previous projections of 7.5%. Interestingly, this denotes a U-turn in RBIs inflation expectations since the previous credit policy review in December, when inflation was projected to have risen to 7.5% from 7% at end-March 2013.

Further, RBI seems a bit concerned that the growth is significantly below trend. While it has brought down its FY2013 growth estimates to 5.5% from 5.8% earlier, RBI admits the growth compression is a result of contraction from the demand side with domestic investment activity as also consumption demand having slowed. Overall, the softening status on growth and also with inflation under control, the RBI could afford to bring down the Repo rate by 25 bps.

Along with this, RBI has also brought down CRR by 25 bps, likely to release around R18,000 crore of liquidity into the system. This, we think is a smart move to ensure the repo cut of 25 bps percolates down to the real sector of the economy. To put this in perspective, a mere 25 bps cut in Repo rate might not have been effective in bringing down the commercial lending rates as deposit growth of the banking sector had been relatively muted. This had led to an increase in the rates offered for deposit mobilisation by some banks, thereby, pushing up their cost structure.

Even as RBI obliged with a repo rate cut, the way forward remains extremely uncertain. RBIs policy statement indicated that growth-inflation dynamics need to be balanced through calibrated easing, and it is critical now to arrest the loss of growth momentum without endangering external stability. Important in this statement are the words external stability. RBI remains worried over the current account gap, which even with some measures to cap gold imports via increase in import duty, is unlikely to cool off significantly. My own estimate for CAD/GDP for FY13 is at 4.4%, correcting to around 3.4% in FY2014 in the event that oil prices come off to average at $105 a barrel in next financial year. Thus, CAD continues to stay as one of the biggest structural risks to the Indian economy, along with the fiscal. Without sustainable correction to the CAD via expenditure-switching and expenditure-reducing policies, it could be difficult for the RBI to continue with its rate easing cycle.

A related issue is the timing of the monetary easing of RBI. It has started easing process at a time when most economies of the world are over with their easing cycle and some are also positioned for a tightening cycle. This means the capital flows into India, especially through the debt flows could be at risk if the RBI eases aggressively, thereby exposing the economy to an external shock.

The other risk could be a re-emergence of the inflationary pressures. This can come through various sources such as a renewed increase in the global commodity prices, rupee depreciation, high food prices and likely emergence of suppressed inflation via revisions in prices of coal and electricity. Assessing all of the above, we think there could be a possibility for RBI to ease repo by 50 bps in CY2013, the first of which should duly happen on March 19.

(The author is chief economist with Kotak Mahindra Bank)