Will RBI's bite be as hard as its bark yesterday?

Even as the chorus for another rate cut grows louder ahead of the Reserve Bank of India’s (RBI) Monetary Policy announcement for 2013-14 on 3 May, the central bank has struck a sharply hawkish note in its Macroeconomic and Monetary Developments in 2012-13 review.

The document, which serves as a backdrop to RBI’s policy announcement, is a grim reminder that though the macro headwinds have eased somewhat, RBI is keeping a close watch on the situation and hopes of a longer duration monetary easing cycle at this point may be unrealistic.

Unveiling the review on the evening of 2 May, RBI says the space for action for 2013-14 remains “very limited” in the wake of macro-financial risks that stay significant and the fact that headline inflation remains above threshold and consumer price inflation remains high.

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[caption id=“attachment_747147” align=“alignleft” width=“380”] RBI is keeping a close watch on the situation and hopes of a longer duration monetary easing cycle at this point may be unrealistic. PTI[/caption]

This view is in sharp contrast to the general opinion among economists and RBI-watchers that there is room not just for further rate cuts, but for a deeper round of monetary easing since commodity prices have eased and headline inflation has moderated.

“If some of the risks come to fore, policy re-calibration may become necessary in either direction,” the central bank warns in its macroeconomic review, almost seeking a toning down of the rate cut rhetoric.

However, RBI does concede that a slow-paced recovery is likely in the later part of 2013-14, but quickly adds that it is contingent upon “improved governance and concerted action to resolve structural bottlenecks”, a clear sign that the central bank will be keeping a close watch on whether the government continues to walk the talk on the promised reform agenda and fiscal consolidation.

Headline inflation, the central bank points out, will remain range-bound in the first half of 2013-14, thanks to lower pricing power by producers and falling global commodity prices. However, in the second half of the fiscal this will begin moving up again due to base effects, it says.

The central bank sees a modest recovery in 2013-14, based on external forecasters’ estimates, which it puts at 6 percent, up from 5 percent and average WPI inflation at a moderate 6.5 percent, down from 7.3 percent. Global growth, the central bank says, will stay sluggish and commodity prices soft.

Growth of the domestic economy, the RBI points out, is likely to have remained low in the fourth quarter of FY13 too and is beset by structural bottlenecks. The central bank has pointed to power shortages, coal and natural gas problems and the stopping of mining activities in some states as key reasons why manufacturing took a beating. Core industries, therefore, underperformed. This view of RBI is also borne out by the PMI indices which pointed often to power shortages and the fact that the finance ministry is also concerned about projects stalled on account of absence of coal and energy linkages.

However, the macro review clearly points to the RBI’s concerns on consumer inflation risks as borne out by the double-digit consumer price inflation number and the divergence between WPI and CPI. Headline inflation and demand-side pressures have moderated, but the inflation risks are evident from the higher consumer inflation, food supply constraints and suppressed inflation in diesel, coal and electricity, the review has said. “Persistent pressures from wages remain a major risk to inflation moderation,” the RBI says in the review.

While all eyes are now on the 3 May policy announcement, the review does come as a sobering backdrop and underscores RBI’s position that while things may have improved somewhat thanks to global macro problems moderating for now, there are continuing risks on the inflation front domestically and that structural bottlenecks are far from sorted. The central bank’s actions on rates will clearly be guided by these concerns, going forward.

Whether these concerns are manifested on 3 May itself - or whether RBI governor Duvvuri Subbarao will give one more push to growth by way of a 25 bps rate cut – is the most important question.