RBI should have paid more heed to global deflation
Given the jump in June inflation and, more important, the Met sticking to its drought forecast—12% shortfall in monsoon, with just 11 of the country’s 36 sub-divisions getting normal rain so far—it is not surprising the central bank has chosen to play cautious and not cut repo rates. With the next policy only in September, RBI will also have more clarity on the Fed’s likely interest rate trajectory. What is odd, however, is that the policy does not seem to have paid sufficient attention to global deflation with most drivers of growth looking weak apart from in the US, and inflation remains below the 2% target for the third year running there. RBI does talk about fuel prices being a mitigating factor in the context of the growth in household inflation expectations rising again—it is odd that RBI has not discarded this completely discredited index—but doesn’t seem to appreciate the larger impact. Indeed, with China accounting for such a large proportion of global commodity demand, the collapse in growth there should logically depress commodity prices further. It is odd that monetary policy statement talks of global economic activity having recovered moderately in Q2 of calendar year 2015 and ends by talking of how growth projections have been revised downward for the year and that the resultant export contraction could become a prolonged drag on growth. Though most data seems to suggest the economy is still fragile, RBI is more sanguine and talks of car sales in July, for instance, improving. That data, however, needs to be interpreted a bit carefully. SIAM data for the industry is not out, and in the case of individual companies like Maruti, the exceptionally strong showing was exaggerated by July 2014 being a weak month. June data for passenger cars and two-wheelers were weak, though June 2014 being a good month needs to be kept in mind.
Governor Rajan’s statement on how the government and RBI were in discussions on fixing what proportion of government bonds could be bought by FIIs, and that this would be denominated in rupees, is good news from the point of view that FIIs will be able to invest more in debt. That should also cushion the impact of the Fed raising rates since this will act as a partial counter to FIIs pulling out of the equity market—the greater the market opened up to FIIs is, the greater will be the counter. Though the Governor said it would be prudent to wait till the government put out the details of the composition of the monetary policy committee (MPC), he seemed to suggest—as the finance secretary did on Monday—that RBI’s powers would not be diluted. In response to a question, he said if the veto was retained, this would not be different from the situation right now; in another, he referred to a former finance minister’s column without going into details—in FE, P Chidambaram had plumped for an equal representation of RBI and government nominees in the MPC with a casting vote, in case of a tie, with the Governor. If this is indeed the case, it will set to rest an unnecessary controversy. The fact that the risks to RBI’s inflation projections are now seen as ‘balanced’ around the 6% target for January 2016 as opposed to ‘upside’ risks in the last policy suggests the room for a rate cut has been left open for later in the year.