Reserve Bank of India (RBI) governor Urjit Patel’s announcement of a quarter percentage point rate cut in central bank’s repo rate on Tuesday isn’t really a surprise. As Firstpost said in an earlier piece today , a conducive environment offered by falling inflation and calls for rate cut from the government to support growth meant that time is ripe now for the Monetary Policy Committee (MPC) and governor Patel to kick off their rate cut season. This may not be a big news for the common man though since a 0.25 percent rate cut hardly eases your EMI burden. But, the action is sentimentally positive to households and industries.
The dominating assumption behind the rate cut, if one goes by the MPC statement, is that food inflation will remain low in near future. “The Committee expects that the strong improvement in sowing, along with supply management measures, will improve the food inflation outlook. It notes that the sharp drop in inflation reflects a downward shift in the momentum of food inflation – which holds the key to future inflation outcomes – rather than merely the statistical effects of a favourable base effect. The Government has announced several measures to cool food inflation pressures, especially with regard to pulses. These measures should help in moderating the momentum of food inflation in the months ahead. This has opened up space for policy action,” the policy statement said.
Will the MPC follow up its action with another rate cut in December? It is unlikely. The MPC has indicated a few other upside risks to the inflation including “the 7th pay commission award on house rent allowances, and the increase in minimum wages with possible spillovers through minimum support prices.”
It notes that the fuller play of these factors will need vigilance to prevent a generalised cost spiral from taking root. Besides these factors, the central bank will also be on a cautious mode on account of an impending US Federal reserve interest rate hike towards December end. After front-loading the rate cut, the MPC may be on a wait and watch mode in the next few months and could go for another cut sometime early next year.
“On balance, the Committee envisages a trajectory taking headline CPI inflation towards a central tendency of 5 percent by March 2017, with risks tilted to the upside albeit lower than in the second and third bimonthly monetary policy statements of June and August respectively,” the policy statement said.
Since January 2015, the RBI has cut the repo rate by a cumulative 175 basis points. The rate currently stands at 6.25 percent. As mentioned earlier, the Consumer Price Inflation (CPI) trajectory, had indicated room for the RBI for rate cut. At the last reading (in August), the CPI inflation fell to 5.05 percent compared with 6.07 percent in July. The RBI has a March, 2017 target of 5 percent inflation. Economists have been saying that the CPI inflation might well fall further down going ahead, given that monsoons this year have been favourable, enabling better crop output.
The larger point here is that the MPC is somewhat confident that the days of super-high inflation triggered by spiraling food prices is over and see scope for more rate cuts going ahead if inflation sticks to the easing path supported by good crop output. In other words, the MPC is likely to be a ‘dove’ than a ‘hawk’ in its policy approach in the foreseeable future. This will be good news for growth-lobby.