Reading Tuesday’s policy statement in conjunction with the one announced in June, we see renewed resolve in the Reserve Bank of India (RBI)’s inflation-fighting approach. The reasons that prompted a rate cut in April— tight liquidity, a likely decline in inflation and expected fiscal tightening — have dissipated at the moment.
RBI is concerned about growth and external risks, but it also sees numerous inflation risks, including pass-through from rupee depreciation, chances of food inflation rising due to a poor monsoon and no move towards fiscal adjustment. Despite slowing growth, RBI sees no discernible easing of demand for protein-rich food products, nor does it see persisting supply side bottlenecks easing anytime soon.
Thus, it was difficult for the central bank to provide any guidance towards policy easing. It stressed its focus remained on inflation; it feels easing the policy now would exacerbate price risks. RBI, however, assured that if global or domestic economic and financial conditions deteriorate in a disorderly manner, it would be ready to act.
We read this as a baseline stance of not altering the policy rates for the rest of this year, with the caveat that a major crisis in Europe or a sharp decline in growth could spring it into action. We would assign no more than a 20 per cent probability to this eventuality.
Given RBI expects inflation to remain at about seven per cent through March next year, there is little disinflation on the horizon, especially as food prices are likely to rise. Provided there is no further flare-up in global commodity prices and growth is well below seven per cent, RBI could see prices flattening enough and the output gap widening sufficiently to ease the policy from March 2013. It could cut policy rates by 100 basis points through 2013, though inflation risks could persist and compromise the magnitude of rate cuts.
Chief Economist, India, Deutsche Bank