Reverse swing: RBI abandons pro-growth stance, takes hawkish approach

Written by Shubhada Rao | Shubhada Rao | Updated: Jun 19 2012, 07:43am hrs
The Reserve Bank of India, at its mid-quarter monetary policy meeting, maintained status quo on policy rates, as it abandoned its pro-growth stance of April 2012 policy in favour of a hawkish approach. While we, along with market participants, had anticipated a 25 bps cut in the repo rate, no action on the rate front has nevertheless not come as a complete surprise to us. The recent print on inflation for May and a sharp upward revision in both headline and core inflation for March were alarming and potentially posed a risk of tilting the monetary policy balance in favour of caution.

In a synchronised intensification of concerns on both growth and inflation fronts, RBI clearly allowed inflation concerns to prompt a pause in the easing cycle following a frontloaded action in April. In addition to adverse WPI inflation internals (as divergence between headline and core inflation widened), significant divergence was noted in core CPI and core WPI, implying inadequate pass though from wholesale to retail prices. The implied demand side pressures, amid supply bottlenecks, have a negative bearing on keeping inflation expectations sticky at elevated levels. With the pass through of international crude oil prices to domestic prices remaining incomplete, and El-Nino conditions remaining a threat to south-west monsoon, the upside risks to headline inflation could perpetuate its divergence with core-WPI and core-CPI respectively.

Since the last monetary policy in April 2012, growth indicators consistently surprising on the downside had swayed market sentiment into expecting further monetary easing amid sticky inflation levels. GDP growth in Q4 FY12 slipped to 5.3%, the weakest print on record, with the annual growth decelerating to 6.5% in FY12, a nine-year low. In addition, the latest IIP print for April 2012 just managed to stay in the positive territory, as it clocked a meagre growth of 0.1%, after a sharp contraction of 3.2% in the previous month. In the policy, while RBI acknowledged the significant slowdown in growth momentum, it highlighted that the slowdown was predominantly driven by weak investment climate largely being held hostage due to policy inaction.

In this context, the RBI highlighted the diminutive role of interest rates in hampering investments. Clearly, the onus of growth revival now lies on the government embarking on a meaningful fiscal consolidation and creating an investment impulse through reforms.

With Fitch following in the footsteps of S&P to downgrade India outlook to negative from stable, the pressure on government has exacerbated to deliver on expectations at large.

Although the government hiked petrol prices last month, an upward revision in diesel, kerosene and LPG prices would help curb the pressure on fiscal deficit. We are hopeful that the government will announce some of these and other measures post the Presidential elections next month. This, in our opinion, would create the space for RBI to address the growth risks.

In its policy guidance, the RBI has left the door open for future policy actions. Eurozone risks, likelihood of further quantitative easing, domestic uncertainties arising from monsoon performance and the resultant dynamics of the growth inflation balance will keep the RBI stance oscillating between pro-growth and inflation management. Assuming and hoping that the government spurs into action, we expect the RBI to complement the supply side impetus by effecting an additional 50 bps cut in the repo rate in the rest of FY13.

The writer is president & chief economist of Yes Bank