Recent trends offer RBI better comfort

There is no expectation of any immediate "rate action" either way from the Reserve Bank of India (RBI). The tone of the central bank's commentary and guidance for future policy action will, thus, be in focus next week. After the relatively dovish statement in June, the RBI adopted a markedly cautious tone in its August meeting.

However, even in the August statement, the governor had kept all his options open, as he continued to emphasise that the central bank's action would be data-dependent.

Interestingly, trends in inflation and expectation thereof have turned favourable since the August policy. International commodity prices have turned materially softer in recent months. Core-CPI has softened below 7 per cent. Wholesale Price Index (WPI)-based inflation, at 3.7 per cent, has hit a five-year low and will likely soften further. Such a level is considerably lower than the RBI's traditional comfort zone of 5.0-5.5 per cent on the WPI scale.

The headline Consumer Price Index (CPI), the key inflation indicator in the RBI's present policy framework, has often been volatile in the recent past. But upsides in CPI prints emanated largely from spikes in volatile items such as food, and not due to broad-based inflationary pressure.

Rather, underlying price pressures appear manageable, given a persistent negative output gap, sizeable excess capacity, weak pricing power in several industries, and a stable rupee. RBI will likely express its comfort on these trends. However, the central bank will like to continue with their stance of caution.

On balance, while next week I expect the RBI to weigh its optimist with caution, I see merit in a more balanced monetary policy stance in the coming months. The recent infusion of liquidity by the RBI remains a welcome step, which has helped the call money rate to soften to an extent.

However, having offered that part of "easing", the RBI might be more cautious before easing the repo rate, which is a stronger step from a signaling angle. I, however, would expect the RBI to eventually adopt a more balanced monetary policy stance in early 2015 and would forecast a 50-basis point reduction in the repo rate in first half of calendar year 2015.

The author is Chief India Economist, Barclays