As the mandarins on Mint Road get ready for another huddle next week, when the Reserve Bank of India (RBI) sits to review its monetary policy, the conflicting signals emanating from the economy have made the central bank’s task tougher than usual.
The first policy review to come up after Finance Minister Palaniappan Chidambaram announced his Union Budget 2013-14, the RBI’s review will hold key pointers to which way the economy is headed and whether RBI governor Duvvuri Subbarao and Chidambaram continue to be on the same page on how to tackle the growth-inflation dynamics.
While the February wholesale price index (WPI) figure which will come up on 14 March will be crucial, the Index of Industrial Production (IIP) figure and the consumer price index (CPI) number which came through this week will surely weigh heavily on the minds of the policymakers at RBI.
With IIP—or factory output—rising more than expected in January, at 2.4 percent thanks to a bounce-back in manufacturing, one part of the story is that growth and economic activity is slowly showing signs of moving back up. A little push from the central bank in terms of a rate action and things may pick up greater momentum. However, viewed against the background of a continuing rise in retail inflation as evidenced by the CPI number, the story takes a different turn. The CPI number at 10.9 percent in February, marginally higher than the January figure of 10.79 percent, shows the stickiness of retail inflation and legitimizes the worry on this count from both the FM and RBI. There has been a clear divergence between WPI and CPI and ultimately, any policy action will have to take this into account.
Despite these conflicting signals, however, general opinion seems to be betting in favor of a 25 basis point rate cut by RBI when it announces its monetary policy review on 19 March. The chief reason for this is the urgent need to get the policy framework to support growth, in continuation of the move by RBI in its last policy review, when the central bank lowered the benchmark repo rate by 25 bps and added on another 25 bps by way of a cut in the cash reserve ratio (CRR) to inject more liquidity into the system.
But clearly, more needs to be done. In an earlier, pre-Budget interview with Firstpost, Romesh Sobti, managing director and CEO of IndusInd Bank had pointed out that despite the earlier rate cut, banks had not really followed it up with cuts at their end, and the cost of deposits had also been moving up over the past couple of months. This, he had said, did not augur well for a downward movement in rates, and another rate cut—together with moves to inject further liquidity—would be imperative, going forward. Sobti had said improving liquidity was essential while cutting rates, since banks were already borrowing far in excess of the ideal level from the liquidity adjustment facility (LAF).
The big factor in favour of a rate cut, by most accounts, seems to be the FM’s indication that he will pull out all stops on getting the fisc back in order. Despite questions being raised on whether the numbers will eventually add up, he has stuck to the 5.2 percent fiscal deficit figure for FY2013 and projected a 4.8 percent figure for FY14. This, analysts are betting, will weigh on RBI which may opt to ease the purse strings and push growth, despite climbing retail inflation.
"The current IIP reading points to very weak recovery that needs policy support at this juncture. While CPI has inched up, we expect it to drop significantly in March 2013 based on seasonal factors. Meanwhile, the fiscal risk may have abated going by the Union Budget for FY14. The latest trade data also brings relief at the margin with significant drop in trade deficit. These factors increase the policy space for RBI. Hence we expect RBI to cut rates by 25bps in its 19 March policy, which should help sustain the moderate recovery in industrial production," explains Dipankar Mitra of broking firm Motilal Oswal.
YES Bank’s chief economist Shubhada Rao too seems to concur with the view that the FM’s efforts will drive the forthcoming policy review. "We retain our call of a 25 bps cut in the repo rate for next week, despite worrying CPI inflation data, as since the last monetary policy, the displayed commitment of the government towards fiscal consolidation in the Union Budget, along with further moderation in WPI and a nascent improvement in trade data, should provide RBI the window to continue to address growth risks."
Indranil Pan and Madhavi Arora of Kotak Mahindra Bank say they continue to expect a 25 bps cut in repo rate given that the RBI is likely to take cognizance of the fiscal compression indicated in the Budget and stick to a series of easing in small doses to enable a better transmission to the real sector.
These assessments by the economist and analyst fraternity could come as a relief for corporate India which is hoping for a fresh round of rate cuts to inject greater momentum into the economy. The WPI figure could still add a fresh twist, though. The FM, on his part, would be hoping his careful attempt at keeping the fisc in check in the Budget would have impressed the RBI governor.