Space emerges for further easing

The Reserve Bank of India's (RBI) October monetary policy meeting is going to be a historic one where all the pillars of modernising the monetary policy framework will be complete with the newly constituted Monetary Policy Committee (MPC), likely to take over the decision-making process. From the introduction of the flexible inflation targeting framework in early-2015 to handing over the reins to the MPC, this paradigm shift in monetary policy making in less than two years, has surely improved the credibility of the central bank in the eyes of the investors and market participants.

The improved credibility and the sudden fall in headline Consumer Price Index (CPI) inflation by 100 basis points (bps) in August has opened up the scope for a 25-bp rate cut in the October policy review, in our view. In fact, we expect CPI to fall further towards four per cent by December and even after accounting for the technical bump of about 50 bps from the implementation of the 7th Pay Commission recommendations, CPI is likely to stay below the RBI target of five per cent in March 2017.

The ‘upside risk’ to the March CPI target mentioned by the RBI, in its August policy statement, appears to have receded substantially, giving the MPC necessary comfort to go ahead with the easing step. Although monsoon rainfall could be a little lower than the initial estimates of the India Meteorological Department, the first advance estimates of summer crop production (up 8.8 per cent year-on-year) is very encouraging. Of the three items pushing up food inflation — vegetables, pulses and sugar — two have already started to moderate. In an unseasonal development, vegetable prices fell in August and with the government expecting kharif pulse production to go up by more than 50 per cent year-on-year in FY17, pulses inflation should now show a meaningful decline. With little visible upside pressure on oil prices or core inflation, we might be entering a prolonged period of very low inflation.

If this forecasted inflation trajectory materialises, then another 25 bps rate cut is possible even after the October policy review. The rather soft activity prints in FY17 would also support such a view. Any easing beyond 50-bps would either require CPI to persistently undershoot the 4.5-5 per cent range that we are forecasting now, or the MPC to outline a different stance on the appropriate real policy rate. While the growth inflation mix does warrant some policy rate easing at this juncture, better monetary policy transmission is still a work in progress.

The author is chief economist at Citi India