Pranab-da is busy; it's back to Subbarao to steer the economy

Reserve Bank of India (RBI) governor Duvvuri Subbarao is in an unenviable position. Having shouted himself hoarse on the need for fiscal consolidation and cut rates by a deep 50 basis points in April to demonstrate that the RBI has done more than its share to get growth back on track, the spotlight is once again on him and the central bank ahead of the 18 June mid-quarter monetary policy review.

Reason? India’s political leadership is currently preoccupied with the jockeying over the Presidential elections and politics has once again taken centrestage ahead of economics. Even as confusion reigns over who will go to Raisina Hill - the finance minister, Pranab Mukherjee being a key contender - Subbarao and his colleagues at Mint Road would have other things on their mind. The one last critical figure to watch before 18 June is in: inflation remained sticky at 7.55 percent in May, broadly in line with what most were expecting. The April inflation number was 7.23 percent.

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The latest inflation figure, though indicating that prices remained elevated, could still force the central bank to cut the key repo rate as a signal from its side that it was doing its bit to spur growth in a situation where it has extremely limited options and supply side constraints show little sign of easing. With growth in the fourth quarter of FY12 at 5.3 percent, the Index of Industrial Production at 0.1 percent and the latest inflation figures, RBI now has all the latest information at its disposal before taking its view on whether to effect another round of rate cuts.

[caption id=“attachment_343932” align=“alignleft” width=“380” caption=“India’s political leadership is currently preoccupied with the jockeying over the Presidential elections. PTI”]  [/caption]

Given Subbarao’s statements after the April policy announcement, analysts may not have expected the central bank to act once again on rates. After all, Subbarao had made it clear that there needed to be credible evidence of fiscal consolidation on the ground and the headroom for further rate cuts could be limited. Barring China, which cut rates recently, even the European Central Bank has held firm on rates and the US Fed has also not committed to another round of quantitative easing. In India, the government has made it clear that a fiscal stimulus package was out of the question.

But Subbarao is once again under intense pressure to cut rates. This is because on the macro side, there’s no evidence of any easing of supply side constraints, the government is still shilly-shallying on hiking diesel prices and there’s no real action on big-ticket reforms which should have been the much-needed trigger for fiscal consolidation. The net result is, RBI will once again be expected to carry the can.

The pressure on Mint Road to act is also greater now because of the poor GDP growth and IIP numbers, both of which indicate that there is no other option but to prioritise growth over inflation for the time being. Particularly because core inflation appears to be easing and oil prices have come off from earlier levels.

Exactly because of this mix of factors, experts have also begun betting on the odds of a rate cut happening rather than not. Core inflation is down at 4.9 percent, while growth has seriously slowed down. Citi India’s Rohini Malkani, for instance, says the rise in headline inflation, when viewed against the fall in core inflation, does complicate policy but ‘odds of easing remain’. Yes Bank’s chief economist Shubhada Rao, on the other hand, says the internals of the latest inflation print are “not comforting”, and makes a rate decision challenging for RBI.

However, Rao too thinks a rate cut is a possibility. “The tepid pace of investment growth, intensified global uncertainties and correction in crude oil prices will provide RBI the grit to cut the repo rate by a measured 25 bps (with no CRR action)” on 18 June, she says in Yes Bank’s Knowledge Report released after the inflation numbers came in.

The slowdown, most agree, is due to government inaction and the policy paralysis which has gripped New Delhi. Even corporate leaders like HDFC chairman Deepak Parekh have voiced their concern at the inability of the government to push through big-ticket reform. Add to that is the recent confusion and drama over the Presidential elections.

But some other key economic factors are now adding up and pointing to a higher possibility of a rate cut. The fall in core inflation apart, growth is well below what RBI says is the trend, non-inflationary level of 7.5 percent. Then, as Malkani argues, is the possibility of Grexit - Greece exiting the Eurozone - and its concomitant impact on India. And then there is the easing of commodity prices, particularly oil.

The decline in core inflation may well hold the key to what Subbarao finally does. There’s also talk in banking circles of the possibility of a cut in cash reserve ratio - the amount of deposits banks park with RBI - to ease liquidity further. Whether Subbarao will effect a repo rate cut and a CRR cut is also a topic of discussion ahead of the policy review, but most now feel a rate cut is inevitable, given the overall economic scenario.

The finance minister is preoccupied with politics. It’s once again back to Subbarao to steer the economy through the next few months. And the RBI governor must now be getting used to waging this lonely battle against a series of economic adversities.