Monetary peace

The big news from Wednesday’s monetary policy review is that the Reserve Bank of India (RBI) now expects retail inflation to stay below the legally mandated 4 per cent mark for the coming 12 months. As a result, the RBI has sharply cut its inflation forecast for the second half of the current fiscal year — from 3.9-4.5 per cent to 2.7-3.2 per cent. For the first half of the next financial year, it has been revised from around 4.8 per cent to 3.8-4.2 per cent. The RBI appeared surprised at the sharp decline in retail inflation, which has significantly undershot its estimates since the October policy. The RBI’s own household survey of inflation expectations over the three-month horizon for November, too, has shown a 40 basis point downward movement over the last round. Retail inflation is expected to fall further — the November data, for example, is estimated at 3 per cent. In a big way, the dip in retail inflation is a result of the unexpected deflation in food items such as pulses, vegetables and sugar. 

Such a benign inflation trajectory would ordinarily gladden the government and indeed push the RBI to at least signal a cut, if not actually cut, interest rates. Indeed, over repeated policy reviews, the RBI has maintained its single-minded focus on targeting only retail inflation and inflation expectations. Despite the recent dip, the monetary policy committee of the RBI was largely unanimous in its decision to neither cut repo rates nor change the stance back to “neutral”. A disaggregated analysis of the components of retail inflation shows why the RBI might have chosen to err on the side of caution. Even though headline retail inflation, which is mapped by year-on-year changes in the consumer price index, has decelerated sharply, thanks to a sharp decline in food and fuel prices, the non-food, non-fuel retail inflation has actual risen to over 6 per cent. Moreover, the RBI is worried about the residual impact of minimum support prices, possible fiscal slippages, and a sudden increase in oil prices in case the Organization of the Petroleum Exporting Countries decides on production cuts. As such, the RBI wants to pause and decide only after ensuring the decline in inflation is of a more robust nature.

But barring a sudden and sharp spike in inflation, the focus will likely shift to the prospects of economic growth. Even though the Q2FY19 gross domestic product (GDP) data undershot the RBI’s projection, the central bank stayed put with its annual forecast of 7.4 per cent GDP growth in the current financial year. Economic growth has suffered in most of the advanced world — both the US and the euro area have slowed even as Japan has contracted in the past quarter. Moreover, several emerging economies such as China and Russia, too, have decelerated. The volatility in global financial flows has marred the prospects further. Yet, the RBI sounded relatively confident about the domestic economy and listed increased capacity utilisation in the manufacturing sector as well as improving credit offtake as key markers, apart from the lower crude oil prices that may boost consumption.