Urjit Patel vs rate-cut lobby: A psychological game is on the cards, not just data crunching

Urjit Patel and his fellow members in the Monetary Policy Committee (MPC) may be having sleepless nights ahead of the bi-monthly monetary policy review slated for Wednesday (2 August). There is immense pressure both from the industry and the government to go for a quarter percentage point rate cut, if not 50 bps (basis points), on Wednesday. One bps is one hundredth of a percentage point.

A direct pitch for a rate cut came from chief economic advisor to the government, Arvind Subramanian, earlier this month after the Consumer Price Index (CPI) slowed to 1.54 percent in June from 2.18 percent in May. “Clearly, this low number (CPI) and what it implies about underlying price pressures—as well as the latest Index of Industrial Production (IIP) data just released—is something that, I am sure, all policymakers will reflect upon very, very carefully,” Subramanian said in a statement (read a Mint report here ). The message from Delhi to Mint Road can’t be clearer than this.

In other words, Subramanian is saying: ‘Look, inflation has come down enough for you to cut rates now. No more excuses.’

Will MPC cut rates on 2 August? It is anybody’s guess still. If one goes by the rate panel’s rationale against a rate cut in earlier policy statements, it wouldn’t.

The fundamental reasons that has prompted Patel and his fellow members to hold rates back then exists even now — a still relatively high core inflation, play of base effects on the CPI numbers, the question of whether the recent dip in CPI numbers is a temporary blip or not, lack of clarity on the full impact of central allowances disbursal and monsoon. Of these, one big factor is base effect, which has played a significant role in the current declining trend. If one looks at June last year, the overall CPI inflation was 5.77 percent (130.1 index) and in July it further rose to 6.07 percent (index 131.1). This means, in July, 2017 too, inflation will have downward bias on account of base effect in last year, probably pushing the print further down.

One question before the MPC could be what will happen when the base effect reverses post-July (inflation started dropping since August last year). This issue has been highlighted by this writer in an earlier Firstpost column .

On the other side, growth worries are growing. In the March quarter, the gross domestic product (GDP) came at 6.1 percent, reflecting the state of economy particularly in the aftermath of demonetisation. Later, the IIP (Index of Industrial Output) data showed a decline to 1.7 percent in May from 2.79 percent in April. In this context, the rate panel has few options but to go for a rate-cut sooner or later.

Not that a rate-cut will work wonders in the economy. As this writer has said several times before, the underlying problems faced by the Indian economy are much more structural than higher borrowing costs. Banks are saddled with high level of bad loans, private investments have not picked up significantly and the manufacturing sector is struggling to get back the desired momentum. Having learned a lesson from the past, banks are not going to shower money on unworthy borrowers even with a quarter percentage point rate-cut.

All the above mentioned problems can’t be wished away with one monetary policy action. Bonds and equity markets may rally for a while if Patel and team opt to go for a 50 bps cut. Fundamentally, nothing really changes in the economy with just one rate-cut.

But none of these reasons may be enough to convince the rate cut lobby. During the UPA-regime, former union finance minister, P Chidambaram had famously said that the government will “walk alone” if need be, after the RBI declined his request to cut rates then. Will we hear something similar from incumbent finance minister, Arun Jaitely? The MPC has so far refused to bend to pressure from the government and has continued with what it thought is right. It can hold the rates one more time and keep the rate-cut announcement for October or it can announce a quarter percentage cut this Wednesday and get it over and done with. This time, a psychological game between the MPC and government is on the cards, rather than a work of macroeconomic data inputs and assumptions.