Why Subbarao will be watching the skies and a lot more

There seems to be just a trickle of somewhat pleasant news coming on the economic front these days. After the Index of Industrial Production (IIP) reading of 2.4 percent for May, the June inflation number at a lower-than-expected 7.25 percent will lead to some relief in policymaking circles.

The inflation number which came in on 16 July will, as usual, lead to calls for another round of rate cuts by the Reserve Bank of India (RBI), with India Inc arguing that growth has been faltering and with inflation now easing a bit, it was time for the central bank to once again loosen the purse strings.

Moreover, with China reducing benchmark rates twice in quick succession and Europe also easing rates, those arguing for another round of rate cut will point to the need for similar easing by RBI when it meets to review its monetary policy for FY13 on 31 July.

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[caption id=“attachment_378687” align=“alignleft” width=“380”]  Core inflation remains flattish, but food inflation for June actually rose marginally to 10.81 percent from 10.74 percent in May. Reuters[/caption]

But chances are, RBI governor Duvvuri Subbarao won’t oblige. After he stood firm and refused to cut rates at RBI’s 18 June mid-quarter policy review, sections of India Inc came up with predictable howls of protest. However, given Subbarao’s earlier statements explaining his stand, it’s difficult to envisage RBI will consider monetary easing just yet. And there’s good reason for not doing so.

One of the key reasons will be that despite the lower June inflation number, inflationary pressures haven’t really eased on the ground. Core inflation remains flattish, but food inflation for June actually rose marginally to 10.81 percent from 10.74 percent in May. Second, and more important, the weak monsoon thus far will weigh heavily on RBI’s mind, since that could once again fuel inflationary expectations.

In fact, a very guarded response from C Rangarajan, the chairman of the Prime Minister’s Economic Advisory Committee, also pointed to the fact that it may not really be time to expect a return to aggressive monetary easing. A weak monsoon will likely impact food inflation once again, causing problems for RBI. At its 18 June policy review, the central bank had said “future actions will depend on a continuing assessment of external and domestic developments that contribute to lowering inflation risks.”

With expectations of a Chinese stimulus and the recent statements from the Chinese authorities on the need to boost the economy, crude prices have once again begun to inch higher, remaining above the $100 mark. This will also be another factor which RBI will have to bear in mind while deciding the future course of action.

On the liquidity front, RBI has already taken steps to ease fund flows for banks by increasing the limit of export credit refinance from 15 per cent of outstanding export credit of banks to 50 per cent, which it said will potentially release additionally liquidity equivalent to a 50 basis points reduction in the cash reserve ratio (CRR). Additionally, it also promised to keep liquidity management on its priority list, using open market operations (OMO) to address liquidity pressures whenever the situation warranted.

Ahead of 31 July, then, Subbarao will be hoping for some steps which address the fiscal side as well. A much-needed diesel price hike and similar measures to reduce the subsidy burden are being talked about, but Rangarajan made it clear he wasn’t able to give a time frame on when he thought that would happen. Not a great signal for RBI, this.

The combination of global and domestic economic factors, despite the slightly improved IIP and inflation numbers, aren’t yet favourable enough for a rate cut. The sooner India Inc factors this into calculations, the less will be the shock on 31 July.

It’s time corporate India realised rate cuts aren’t the only way of dealing with the situation. As the RBI governor said at the last policy review, “factors other than interest rates are contributing more significantly to the growth slowdown.” And he was just being polite.