Clear skies cloud rate-cut hopes

The rain gods have not been favourable so far, raising doubts on the Reserve Bank of India (RBI)’s ability to cut rates to revive the slowing growth of the Indian economy.

Seasonal rainfall in the country till June 27 has been 23 per cent below the long-period average (LPA) and was below normal overall regions except east and Northeast India.

While the India Meteorological Department (IMD) has predicted normal rains in the current monsoon season (June-September), it has cut forecast to 96 per cent of LPA from the initial prediction of 99 per cent in April. IMD has also cautioned that the risk of El Nino conditions in the later part of monsoon season still exists.

Citigroup global markets’ economist Rohini Malkani said Indian economy is “not yet water-proof”. According to her, poor monsoon will have more impact on prices than growth. “While sub-par monsoon could shave 50-80 basis points off growth to 5.6-6.0 per cent, the impact on inflation is difficult to quantify... Despite high food stocks, poor monsoon would further aggravate the price situation,” Malkani said in a recent note to clients. She said she expected headline inflation to stay high at 7.5 per cent in 2012-13.

Wholesale price index (WPI)-based inflation had moderated in 2011-12 from a peak of 10 per cent in September 2011 to 7.7 per cent in March 2012. However, in the current financial year, provisional data suggest that it has started to climb again. The WPI inflation rose to 7.6 per cent in May from 7.2 per cent in April.

“Clearly, bad monsoon will put pressure on food inflation and limit RBI’s ability to cut rates further. Any monetary easing will likely be contingent on retail and wholesale inflation moderating and steps by the government to keep the fiscal policy on track,” Sajjid Chinoy, India economist at JP Morgan, said.

High inflation prompted RBI to keep interest rates unchanged in its mid-quarter monetary policy review earlier this month. This was despite industry associations urging the central bank to pare key policy rates to stimulate investment and trade activities.

RBI Governor D Subbarao in a seminar organised by the Confederation of Indian Industries on June 19 admitted that monsoon will play a key role in determining the central bank’s actions on interest rates.

“When I joined service, I did not worry about monsoons. But when I first went as sub-collector in Andhra Pradesh, there was drought in one of the districts and then I realised how not only economic prospects but also emotional well-being are tied to the monsoons. Then I moved away from the field and stopped chasing monsoons. So, at the end of my career, when I’m at the RBI, I sort of look at monsoons with lot of anxiety, love and lot of expectations. It is very important for us,” he added.

RBI will review its monetary policy again on July 31. Economists and industry analysts have said they feel the banking regulator may keep rates unchanged again if rainfall does not improve. “If pressures on food inflation play out, RBI may not go for rate cuts in the first half (of 2012-13),” Indranil Pan, chief economist at Kotak Mahindra Bank, said.

“As monsoons have delayed this year, we can expect its impact on prices of primary articles, resulting in rising inflation. Probably RBI would wait and watch to take any further action on rate cut in the next policy review scheduled for July-end,” Abhishek Goenka, founder and chief executive of India Forex Advisors, said.

According to economists, it is critical that monsoon gathers pace in coming days as sowing season has started.

They added that insufficient rains will put upward pressure on food prices and will force RBI to keep interest rates unchanged.