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Statsguru: Is RBI's status quo justified?

Recent economic data make it difficult to justify the policy stance

Ishan Bakshi 

Statsguru: Is RBI's status quo justified?

Despite the growing clamour for a rate cut, the monetary policy committee (MPC) of the chose to maintain the status quo in its latest policy review. The benchmark repo rate remains at 6.25 per cent, as shown in Chart 1.

But the recent economic data make it difficult to justify the policy stance.

On the inflation front, the consumer price index (CPI) dropped to 3 per cent in April, with even the core inflation rate declining marginally to 4.4 per cent, as shown in Chart 2.

Excluding petrol and diesel captured in the transportation segment, the core inflation rate is even lower at 4.1 per cent. And, while household inflation expectations remain elevated, they have moderated of late.
As shown in Chart 3, median expectations of current inflation levels have dropped to 6.3 per cent, while expectations of inflation three months ahead have dropped to 7.3 per cent.

On the growth front, there is reason to be concerned. Economic growth slumped to 6.1 per cent in Q4FY17.

Excluding government spending and agriculture, gross value added (GVA) grew by a mere 3.8 per cent in the fourth quarter. It is especially worrying that investment activity contracted by 2.1 per cent in Q4FY17, as shown in Chart 4. It has been slowing consistently in FY17.

And with the twin balance sheet problems continuing to persist, a revival in the investment cycle seems unlikely in the near term. Debt-laden companies simply do not have the capacity to borrow for fresh investments and banks continue to struggle with their non-performing loans (Chart 5).

As a consequence bank lending to industry has contracted in the past few months as shown in Chart 6.

Demand continues to remain sluggish as shown in the low capacity utilisation rates in Chart 7.

This, despite the MCLR rates declining by 70 basis points after demonetisation, suggests that perhaps real interest rates continue to remain too high.