Over the next few days, the Monetary Policy Committee (MPC) is scheduled to hold its third bi-monthly meeting. Coming against the backdrop of a falling retail inflation rate and a sluggish industrial growth, expectations of a looser monetary policy stance are gaining traction. As Chart 1 shows, the retail inflation rate, measured by the consumer price index, fell to 1.5 per cent in June, well below the RBI’s target of 4, plus or minus 2 per cent. This decline was driven largely by falling food prices. As shown in Chart 2, the consumer food price index contracted by 2.1 per cent in June. Further, core inflation, which had remained sticky so far, also moderated in June, implying a weakening of demand. Some economists expect the inflation rate to rise in the coming few months, with the base effect wearing off. But, despite this, the year-end inflation forecasts continue to show it at the lower end of the RBI’s target. On the investment side, there is still no sign of a broad-based recovery, with the twin balance sheet problem weighing down both new investment activity and bank lending. Gross fixed capital formation contracted in the fourth quarter of FY17, as shown in Chart 3.
An immediate pick-up seems unlikely with industrial activity being sluggish in the first two months of the financial year. The index of industrial production dipped to 1.7 per cent in May, as shown in Chart 4. Further, within the IIP, the capital goods segment, which connotes investment demand, contracted by 3.9 per cent in May, as shown in Chart 5.While some economists were concerned about the implications of a tighter US monetary policy, the US Federal Reserve kept its benchmark lending rate at 1-1.25 per cent in its latest meeting. With central banks across the world being cautious in their approach, it creates room for the MPC to cut interest rates. (Click on picture for details)