Jan 2016 target suggests no rate cuts in a hurry
Given the collapse in headline CPI inflation, from its November 2013 peak of 11.2% to 7.3% in June, and this was despite the remarkably poor monsoon, it was reasonable to expect RBI to cut rates in its August review, more so given the fragile nature of economic growth. The impact was even greater when you looked at the annualised month-on-month percentage changes, which showed CPI fell to 4.3% in January to June this year from 9% in the same period a year ago. Apart from the obvious base effect that caused headline inflation to fall, there were other reasons for why inflation fell. For one, with the government clamping down sharply on expenditure, rural wage growth has begun to slow; the fact that the NDA, apart from promising to stick to the UPA’s ambitious 4.1% deficit target, kept an FY15 expenditure growth trajectory lower than that of expected nominal GDP growth also indicates it is serious about expenditure compression. In addition, there was the reining in of minimum support prices which, in the past, have been a major reason behind high inflation.
The question is whether inflation will remain benign or, as growth picks up, it too will begin rising. Which is why, as RBI puts it, ‘while inflation at around 8 per cent in early 2015 seems likely, it is critical that the disinflationary process is sustained over the medium term’. And, of its 6% CPI target for January 2016, RBI says the risks ‘are still to the upside’. Indeed, which is why RBI Governor said he was trying to lift impediments on the supply side—cutting CRR/SLR/priority sector obligations for banks raising infra bonds or cutting SLR on Tuesday—while trying not to give too much of a boost to consumption.
While most analysts have ruled out a rate cut till 2016 based on RBI’s hawkish statements—which are, in turn, predicated on the unusually tough 6% target for January 2016—a lot depends on how things play out; that is, on inflationary expectations. Though the impact of this is yet to get worked out fully, the government’s plan to dip into its bulging food reserves to control cereal prices, is a big inflation dampener—the fact that the reserves are in excess by 34 million tonnes makes it clear the government has a pretty big bazooka should it choose to use it. If the government is able to get the alternate mandis going to bypass cartelised APMC mandis, in big centres like Delhi, chances are this will also dampen food inflation. Getting stuck projects going, to create enough capacity to meet demand rising as economic growth picks up will also help keep core inflation down. For now, though, with banks stuck with so much liquidity, interest rates will remain soft, more so given the R 40,000 crore RBI has freed up with the cut in SLR rates. The only problem is, with no help on the interest rates front, it is not clear what will drive economic growth, more so with global exports growth projections being pared once again.