While inflation hawks, and currency markets, were looking to a rate hike from RBI at the time of the last monetary policy in October, the continuous slowing in CPI inflation rates makes it clear the central bank took the right call in keeping rates on hold—the rupee crashed past the 74 mark when RBI didn’t mount the interest-rate defence most expected for the rupee. CPI levels have fallen further since, from 3.7% for September to 3.3% in October. With CPI averaging 4.1% from April to October, chances of inflation rising above RBI’s comfort zone are limited, more so since the base effect for November-to-January alone will also ensure lower inflation numbers. Indeed, while RBI had initially forecast a 4.6% retail inflation for Q2FY19, it lowered this to 4% in the October policy; it lowered CPI for H2FY19 from 4.8% to 3.9-4.5%. And keep in mind that, when RBI was formulating its policy in October, the rupee crashed below the 74 mark while it has, since, recovered to Rs 72.3; and while some were even talking of $100 oil in light of the impending US sanctions on Iran, oil is at $66 today. In which case, RBI may have been a bit hasty in even changing its stance from neutral to ‘calibrated tightening’, though Governor Urjit Patel was quite clear, in the post-policy press conference, that this meant the central bank could raise rates, but did not mean it would.
Apart from this, as several, including this newspaper argued, an interest rate defence wasn’t going to help the rupee since the currency wasn’t falling just because of the widening CAD, it was the direct impact of the strengthening dollar vis-a-vis all emerging market currencies. Also, an interest rate hike would hurt equity investors. And, in any case, an inflation-targetting central bank couldn’t really raise interest rates to protect the currency in the face of a benign inflation outlook.
Some will still argue inflation remains out of control since core inflation continues to rise, by 39 bps in October, to 6.2% year-on-year. But, as analysts at Credit Suisse and Nomura point out, the bulk of the increase in core inflation came from the ‘health’ segment which could possibly be a one-time adjustment to the fall in the value of the rupee or simply a data error. The larger issue is that there aren’t too many demand-side reasons for inflation to rise and, to the extent that interest rates in the economy are already nudging up, demand will further contract; the post-IL&FS squeeze will also ensure that NBFC credit growth slows, once again putting a lid on demand-side inflationary pressures. Apart from the slowing global growth, the fact that the government is likely to face a shortage of revenues—due to lower-than-expected GST and disinvestment revenues—means that government spending, that has been a big driver of growth, will slow in the coming months. And while the output gap is narrowing, there is substantial unutilised capacity so as to ensure that inflation remains benign even if the pace of demand picks up over the next few months. In the event, Nomura economists are looking at GDP growth slipping from 8.2% in Q1FY19 to below 7% by Q4FY19 and headline CPI inflation to average around 4.5% in calendar 2019 and core inflation to converge around 4-4.5% by mid-2019. In which case, it is unlikely RBI will be raising rates in the next policy in December and possibly even the one in February 2019.