Forget inflation, SC's coal verdict ensures RBI won't be cutting interest rates today

Reserve Bank of India (RBI) governor, Raghuram Rajan has yet another reason tonot lower his guard in thefight against high inflation– the likelihood of fuel price increases, arising out of the revised coal scenario and new gas pricing formula, being passed on to the end-consumer.

On Wednesday, the Supreme Court cancelled 214 coal blocks allocated to steel, cement and power companies between 1993 and 2009 after maintaining the allocation process illegal a month earlier.

Since the Supreme Court has quashed the coal block allocation, the government will now have to start the allocation process afresh. On re-allocation of the blocks, coal prices arelikely to go up and ultimately result in higher electricity prices and thus stoke inflation.

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“The renewed coal scenario most likely would lead to an increase in coal prices,” said India Ratings and Research, formerly known as Fitch India, in a note.

Besides, an upward trend is likely to be seen in gas prices as well post the revised pricing formula, currently being considered by the government, which will contribute to further inflation, India Ratings said.

“In case the fuel price hike is passed through completely it will stoke inflation,” the agency said.

The only way thiswon’thappen is if state-electricity distribution companies (discoms) absorb fuel price increases or state-governments offer budget allocations to absorb the burden of distribution units. But the chances of such a cost absorption happening appears low, since the financial health of discoms is already weak on account of transmission losses and theperiodical tariff revisions not taking place for a long time. Fiscal constraints may also not permit state governments to make budgetary allocations to absorb cost shocks.

For the RBI, its focus remainsbringing downinflation and restoring price stability in the economy. To fight inflation, the central bank has hiked the repo rate, at which it lends short-term funds to banks, thrice by a total of 75 basis points (bps) to 8 percent and opted to maintainstatus-quo four times. One bps is one hundredth of a percentage point.

Since Rajan took charge in September last year, hehas presided over seven monetary policies. For the same reasons, it is illogical to expect a rate cut from the central bank before inflation eases on a sustainable basis.

“With RBI pushing to bring down CPI inflation to 6% by January 2016 the time line for monetary easing under the emerging scenario becomes even more remote in the foreseeable future,” India Ratings said.

The central bank, which has openly declared battle against retail inflation, won’t take the chance of ignoring signals that could result in an upward pressure on inflation.Inflation targeting has already been accepted informally by the central bank as its policy stance. The RBI has been repeated multiple timesits target to bring down retail inflation to 8 percent by January 2015 and to 6 percent a year later, in keeping with thethe recommendations of the Urjit Patel committee.

The consumer price index (CPI) based inflation stood at 7.8 per cent in August compared with 7.96 per cent in July but food inflation, a major concern for the central bank, hardened to 9.42 per cent from 9.36 per cent a month ago.

The stubbornness in food inflation was primarily due to a 15.15 per cent jump in vegetable prices and 24.27 per cent jump in the fruit prices, putting pressure on overall price levels.

Even though the price impact arising out of the likely increase in coal, gas prices won’t beimmediate, the possibilityof this happening can impact inflationary expectations in the economy. Retail inflation has stayed close to double digits for most part of last year, even though for the last three months the CPI has stayed below 8 percent.

Rajan, who wants to “fight the anti-inflationary fight once and for all,” would want to see a sustainable slowdown in the price levels, before beginning to cut rates.

Hence, the central bank, in all probability, will maintain a status-quo in its key rates on 30 September.