Falling growth versus persisting inflation risks: What will win the heart of rate-setting panel this June?

The April retail inflation data, coupled with not-so-encouraging growth figures released so far, are compelling reasons for the Monetary Policy committee (MPC) to press the rate cut button on 6 June

Dinesh Unnikrishnan May 14, 2019 12:14:46 IST
Falling growth versus persisting inflation risks: What will win the heart of rate-setting panel this June?
  • April retail inflation data, coupled with not-so-encouraging growth figures released so far, are compelling reasons for MPC to press the rate cut button

  • Since October, 2018, core inflation too has been largely on a declining trend

  • In April, core inflation stood at 4.25% compared with 4.75 % in March and 5.8 percent in April last year

The April retail inflation data, coupled with not-so-encouraging growth figures released so far, are compelling reasons for the Monetary Policy committee (MPC) to press the rate cut button on 6 June when it meets next for the next bi-monthly monetary policy review. The consumer price index (CPI) was recorded at 2.92 percent in April. That’s the sixth consecutive month the CPI inflation is staying below the 3 percent mark.

What is even more interesting to note is the trajectory of core inflation, which typically is a key metric the Reserve Bank of India (RBI) looks at for policy calculation purposes. Core inflation excludes volatile food and energy components. Since October, 2018, this metric too has been largely on a declining trend. In April, core inflation stood at 4.25 percent compared with 4.75 percent in March and 5.8 percent in April last year. Going ahead, low base effect will likely push inflation readings upward. But, for now, inflation presently stays largely within the comfort zone of the RBI and lower core inflation should ideally give room for a rate cut in June.

Falling growth versus persisting inflation risks What will win the heart of ratesetting panel this June

Representational image.. AFP.

That’s about inflation readings. What about growth? Slowing growth is another reason for the MPC to go for a rate cut. Economic growth has been struggling to recover for a while now. How do we know that? When growth slows, economic activity on the ground (consumer spend, corporate sales, vehicle sales, pace of manufacturing, construction activities, service-oriented businesses) slows commensurately. And those indicators are flashing the red now.

Car, two-wheeler and tractor sales have been declining with companies grappling with piled-up inventories thanks to muted demand. Factory output has been dropping for nearly a year now and the main villain has been poor performance in manufacturing sector.

How can a rate cut support growth? Theoretically, when borrowing costs are lowered, it encourages consumer spending—buying houses, vehicles and goods. That gives a leg-up to the economy. But, does that happen in reality? Banks rarely pass on the benefit of RBI policy rate cuts to consumers, which is why RBI always laments about the lack of monetary policy transmission.

Even if banks hesitantly cut rates by a few basis points, that may not be enough to nudge consumers towards fresh buying decisions. But, in a slowing economy where inflation is largely under control, there is always pressure on the monetary authority to cut rates.

But hold on, there is still a possibility that the MPC may not go for rate cut in June and wait till August.

One of the reasons for not going for a rate cut as of now is because there is no clarity on the monsoons. The Indian Meteorological Department (IMD) has predicted ‘near-normal’ monsoons this year. The rainfall from June to September is likely to be 96 percent of the 50-year average of 89 cm with a model error of +/-5 percent. But that prediction is a tad different from the forecast from Skymet, a private firm, which predicted ‘below normal’ rains this year. If there is below normal rains, inflation will face an upward pressure primarily on account of rising food prices.

Secondly, the course of fiscal deficit will be a deciding factor. Till February, the fiscal deficit had touched 4.52 percent. While this looks worrying considering the 3.4 percent target, the final number may get adjusted when the March numbers come in. Even then, the fiscal scene is likely to be under pressure on account of expected revenue shortage and expenditure burden in a post-election year.

Thirdly, the course of crude will be watched. If there is a further spike in international crude prices, this can have major ramifications on fiscal arithmetic because India relies on imports to meet approximately 80 percent of its domestic oil demand. Higher oil prices can push up inflation.

These three factors will prompt MPC to pause and wait for further clues. Will the rate panel ignore these concerns and give more weightage to growth concerns? One needs to wait and watch.

(Data support by Kishor Kadam)

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