RBI's 'on-hold' policy coming to an end

The central bank’s strong anti-inflation rhetoric since June has dampened the earlier market expectation of rate cuts in September and to an extent over the remaining months of 2012-13 as well. I, however, remain biased in thinking RBI will eventually deliver more easing in 2012-13 than what the market is currently pricing in.

The growth trajectory has settled at 5.5 per cent for a while and RBI looks set to miss its 2012-13 growth target of 6.5 per cent by a considerable margin. Demand from investments and exports had been weak for long. Of late, consumption demand seems to be tapering as well. This can potentially drag growth weakness longer.

As a result, reviving growth would likely turn into a bigger priority in the next three to six months. Given the near-zero fiscal spending headroom, and likely only hesitant government policy initiatives to revive the economy, monetary policy seems the only major spanner in the policy toolkit. I pencil in a cumulative 150-basis point repo rate cut in 2012-13 (of which 50 bps are already delivered).

Headline inflation is unlikely to soften quickly, especially with upside risks due to fuel price rises. Core inflation will, however, cool further in the coming months. Demand for several key drivers of core inflation (such as textiles, metals, chemicals, industrial equipment) remains weak. The spillover of potentially higher fuel and food inflation, unless dramatic, on to core inflation will likely be smaller now, given poor industrial demand and weaker pricing power.

The steady improvement in monsoon rains in recent weeks has marginally eased food inflation concerns. Fuel price rise-led inflation, on the other hand, should be seen primarily as a statistical phenomenon. In fact, apart from helping fiscal consolidation, fuel price rises would be a somewhat restraining factor for the economy and, thus, raise chances of rate cuts.

September policy still remains a close call. The August inflation print on Friday and whether there is finally any constructive step towards fuel price adjustments would have a considerable last-minute bearing on Monday’s RBI decision. One cannot rule out a token easing if such factors oblige. RBI’s rhetoric is likely to be more balanced this time.

 

The writer is chief India economist, Barclays