Hawkish RBI dents market hopes

Sees very limited scope for further easing of monetary policy, puts growth ball in govt's court

A day ahead of its annual monetary policy announcement, the Reserve Bank of India (RBI) on Thursday warned of only a “very limited” scope for further easing of monetary policy in the current financial year, striking a hawkish tone.

In its report on macroeconomic and monetary developments, the central bank said headline inflation was likely to stay above its comfort level, though it had moderated in the second half of 2012-13. In addition, high retail inflation, hovering around double-digit levels, would make things difficult.

RBI, in fact, has gone a step ahead and warned that interest rates could even be raised later if some of the inflation risks came to fore. “If some of the macroeconomic financial risks come to the fore, policy recalibration, in either direction, may become necessary” RBI said.

The central bank’s cautious language could dent the rising market hopes for Governor Duvvuri Subbarao to adopt a more dovish stance, heralding further easing this year. Market participants are expecting at least a 25-basis-point rate cut tomorrow, along with another 25-bp one in the next policy review in June. The yields on the 10-year benchmark government paper, which had softened almost 30 bps since the beginning of the financial year, on Thursday closed at 7.72 per cent.

Some economists, however, said the quarterly report did not always give a clear indication of what the following day’s policy move would be.

On the issue of reviving growth, the central bank put the ball in the government’s court, saying recovery was contingent upon improved governance and a concerted action to resolve structural bottlenecks, especially in the infrastructure sector. RBI also said monetary policy easing in 2012-13 had not succeeded in turning investments around.

Though headline inflation is likely to remain range-bound in 2013-14, RBI expects some further moderation in the first half of the year due to subdued pricing power of producers and falling global commodity prices, before a rise in the second half, largely due to base effect.

Though the recent fall in the global commodity prices, coupled with a subdued demand, would result in further moderation in inflation in the next few months, price adjustments in diesel, coal and electricity, when effected, might offset the inflation moderation due to slack demand, RBI said.

“Moreover, food inflation remains a major pressure point accentuated by continuing supply bottlenecks,” it said.

According to the central bank, the monetary policy stance in 2013-14 will depend on three key issues — decelerating growth, comparatively high retail inflation and external vulnerability. The risks of high current account deficit would stay, though fall in global commodity prices would bring temporary respite, RBI said.

The RBI survey of professional forecasters lowered its growth forecast for the financial year that started in April to six per cent, from 6.5 per cent in its previous survey.

THE SIX RISKS
Key risk factors for growth and inflation outcomes for 2013-14, according to RBI

* Deceleration in consumption could delay recovery process
* Risk of a sub-normal monsoon to growth and inflation, though forecast has been of a normal monsoon
* Supply-side constraints, if not removed, could prove the biggest risk to recovery
* Fiscal risks lowered but not over, as further growth slowdown could result in revenue shortfalls
* Global risks still remain significant; these can lead to sudden stoppage and reversal of capital inflows
* Global inflation could stay muted but the large doses of QE, liquidity could feed into long-term inflation expectations