What that means is real interest rates are rising at a time when inflation is low and the growth impulse weak
With inflation remaining as low as it has and with abundant food production—at 9%, growth in foodgrain production in FY17 was the highest in six years—it is not surprising RBI has slashed its inflation outlook. Just two months ago, it had forecast a 4.5% CPI-inflation in H1FY18 and 5% in H2; those projections have been revised to 2-3.5% and 3.4-4.5%, respectively. That’s a whopping 175 bps lower for H1 and 100 bps for H2 and explains why, after the policy statement, chief economic advisor Arvind Subramanian talked of projections that were “large and systematically one-sided in over-stating inflation”—while the central bank had forecast a 5% inflation for March 2017, the actual print was 3.9%. What is inexplicable is, despite this, RBI not cutting rates and preferring to, instead, “remain watchful of incoming data”. After all, the central bank has itself pointed out that the seasonal uptick in food prices, typical before the onset of the monsoon, has been muted this time around—last year, inflation rose from 4.8% in March to 5.8% in May while, this year, inflation is set to fall from 3.9% to below 2.5% over the same period. Given the monsoon is expected to be a good one this year, it is unlikely prices of cereals and vegetables will go up sharply, if at all. More critically, the central bank cites the PMI data—both manufacturing and services—as also the industrial outlook survey as evidence of weak pricing power. The high level of unutilised capacity in
More critically, the central bank cites the PMI data—both manufacturing and services—as also the industrial outlook survey as evidence of weak pricing power. The high level of unutilised capacity in industry, at close to 25%, doesn’t look like it is coming down in the near future, and will further dampen pricing power. In any case, one would assume all potential upside risks to inflation—like rising rural wages and the secondary effects from the hike in allowances for government employees—would have been pencilled into RBI’s inflation projections, which is why its statement says ‘risks are evenly balanced’ even though the monsoon and effective food management continue to remain critical. The possible spate of loan waivers across different states following the one in UP, though, is something the central bank needs to worry about.
Even if the unusually low inflation in April—a historic low of 3.2%—does not endure as the transitory effects of demonetisation wear off, it is hard to see any runaway rise in prices. Activity in several sectors, including key spaces such as construction and real estate, remain sluggish, and even the re-monetisation is not expected to result in any sharp rise in consumer spends—the central bank itself has lowered its FY18 GVA growth outlook to 7.3% from 7.4% just two months ago. With large output gaps, as BoFAML’s India economist Indranil Sengupta points out, core CPI inflation has fallen from 4.8% in October to 4.1% in April. While RBI is right in pointing out that the twin balance-sheet problem was delaying a revival in private investment demand, with the economy losing momentum and the inflation outlook benign, there was a definite case for easing monetary policy. Even if lower rates do not lead to any meaningful pick-up in investment in the short run—that requires banks/corporate to be in better shape and the demand outlook to be less hazy—it would help anyone who has a bank loan, from individuals to both small and large companies.