Inflation is lower but Raghuram Rajan may still not cut rates before Budget

Regardless of a mild rise in the consumer price index (CPI) inflation numbers to 5 percent in December from 4.38 percent in the preceding month, the clamour for a rate cut in the February bi-monthly monetary policy review of the Reserve Bank of India (RBI) is getting louder. Those argue in favour of a rate cut point out the steady decline in the CPI inflation, the key price indicator for the central bank for policy formulation, over the past few months. An expert panel under RBI deputy governor Urjit Patel had targeted 8 percent CPI in January 2015 and 6 percent a year later. Inflation has already fallen way below these estimates. In that sense, the retail inflation has excelled the expectations of the RBI by dropping below 6 percent in three consecutive months, thus obliging to the central bank’s glide path. On the other hand, the demand for a rate cut is intense in the face of faltering corporate growth. Lower borrowing costs can certainly give a push to companies, as well as consumers. [caption id=“attachment_2045339” align=“alignleft” width=“380”]  Reuters[/caption] If one looks for clues purely from the inflation numbers, a quarter percentage point rate cut can well happen in February that would take the repo rate, or the key lending rate, to 7.75 percent and would mark the first rate cut in Rajan’s tenure. This will be followed with another 25 to 50 basis points (bps) cut during the course of the year. One bps is one hundredth of a percentage point. But a cut in repo rate in February will tantamount to lowering the guard before the battle is over for Raghuram Rajan. The former economist has made his idea of fighting inflation clear several times in the past, saying he wants finish the fight for once and for all and explained why one shouldn’t get swayed by the inflation data for a month or two. A rate cut in February, in that sense, will be a premature proposition for Rajan and could spoil his game plan of controlling the price worries in the economy. Now, read this with the December guidance of Rajan. “If the current inflation momentum and changes in inflationary expectations continue, and fiscal developments are encouraging, a change in the monetary policy stance is likely early next year, including outside the policy review cycle”. There are no convincing arguments to conclude that the recent decline in inflation is permanent in nature. On the contrary, there are a few to believe that rate cut is likely to happen only in March-April period, even outside the policy dates. For one, Rajan has time and again stressed the importance of reciprocity from the fiscal authorities to complement the efforts put in by the monetary policy to set things right in the economy. The Union Budget, likely to be announced by end-February, will be something the RBI will be eager to look at before charting the future course of monetary policy. Second, one major reason for the big fall in CPI numbers in October (5.52 percent) and November (4.38 percent) is the high base effect of last year. A higher base in the corresponding period in the previous year will result in a lower number this year, even if the quantum of growth is same. In October and November of 2013, CPI inflation numbers stood in double digits, 10.09 percent and 11.16 percent, respectively. The high base began fading in December as in the corresponding period in 2013, CPI fell to 9.87 percent. This has somewhat reflected in the December 2014 CPI numbers, which inched up to 5 percent. Going ahead, the benefit of base effect will vanish further. Rajan would, perhaps, want to see how the inflation pattern behaves then. The January inflation numbers will come only in mid-February. Third, the food inflation has actually risen to 4.78 percent in December from 3.14 percent in November. Food prices typically ease in winter but moves north as summer approaches. Food inflation is a bigger concern for the central bank, as it has stressed all along in the past, and Rajan will probably wait to see the Jan-Feb inflation numbers to see the trend. On Wednesday, the wholesale price index (WPI)-based inflation data for December showed a marginal rise in the inflation number. Even though WPI doesn’t assume much importance in the central bank’s scheme of things when it comes to the policy formulation, the trend on food inflation is important to note. Food inflation in the WPI-index rose to 5.2 per cent from 0.63 per cent in the preceding month. This wouldn’t be a trend that would give comfort to Rajan to go ahead with an early rate cut. Fourth, the previous round of surveys conducted by the central bank had suggested high inflation expectations among the general public. The central bank wants to contain high inflation expectations in the economy and has highlighted this aspect in past policies. Such surveys are subjective assessments of around 5,000 households across 16 cities and are based on households’ individual consumption baskets. The October-December survey is currently on. It is prudent to expect the rate cut cycle to kick in post the budget, in March-April. For now, Rajan is likely to keep his cards close to his chest, unless the former IMF chief economist chooses to go back to his reputation of springing surprises. (Data support from Kishor Kadam)