Decision-making enters a difficult zone

There is almost full consensus that the Reserve Bank of India (RBI) is unlikely to lower the repo interest rate in June, especially after signalling in the last policy that it would keenly monitor liquidity dynamics and infuse “primary liquidity” to support its accommodative stance. Further out, the market remains hopeful that RBI could deliver a last 25-basis point repo cut around August, post clarity on monsoons.

Though not a zero probability yet, scope for RBI to implement more repo cuts is shrinking at a fast pace and this could be irrespective of the monsoon dynamics. While headline Consumer Price Index (CPI)-based inflation increased to 5.4 per cent in April, the cereals inflation that should mostly get affected by the monsoon is not too significant even today and is at around 2.5 per cent. Vegetables and pulses prices have been volatile and might continue to be so in the near future.

Beyond the food prices, the key issue that is not easily ignorable is the firm to firming core inflation measure. Core inflation averaged at 4.5 per cent in FY16, definitely down from early FY15 levels of 8 per cent or whereabouts, but any incremental softening bias might be a dream. Note that one of the significant comforts for core inflation came from dips in domestic prices of petrol and diesel, enabled by a drop in the global crude oil prices. From the date of the April policy announcement to today, global Brent oil prices have moved higher by 31 per cent while the currency has also been on a depreciation bias.  

Leaving the above aside, inflation levels from the other components of the core has been extremely sideways and in a 5 per cent-plus zone, even with a baseline argument of a continuing demand slack in the economy. This, as has also been pointed out by RBI in its April monetary policy, is clearly indicative of capacity constraints in the services sector — education, housing, health care etc. With nothing getting done to enhance capacity in these areas, the downward bias for headline CPI inflation could be restricted. Further, headline WPI (Wholesale Price Index) has turned positive now, and should reflect on retail inflation with a lag.

Scope for dips in core and also headline CPI inflation might also be restricted as economy pundits expect growth momentum to improve with a pick-up in consumption demand via monsoon-linked improvement in rural demand and due to increase in disposable incomes through implementation of the Pay Commission. In the above scenario, the lookout from the policy will be more on the communication and the guidance on growth and inflation. US Fed moves, Brexit and China trends and the consequent implication of the same on global financial markets would be a critical input for RBI in its decision for incremental repo rate cuts.

The author is group chief economist, IDFC Bank Ltd