Though RBI has boxed itself in by conveniently referring to elevated levels of CPI and the current account deficit (CAD) as being the reason for not cutting policy rates from time to time, and then ignoring them when it has felt the need to cut rates, it is clear that if a rate cut is to help, this has to be accompanied by a CRR cut. Right now, with low deposit growth, banks have no option but to hike deposit rates across different tenure—so the only way to break this cycle and lower lending rates is to cut CRR or find other ways to infuse liquidity. Theoretically, come April 1, the government will start spending and this will automatically increase liquidity, but there is no certainty as to how the pace of spending will pick up—the borrowing calendar, announced Monday, has less frontloading of borrowing as compared to FY13, suggesting government spending will pick up soon.
While many have argued the high CPI will make it difficult for RBI to cut rates, that doesn't really wash. If a 10.6% headline CPI in December didn't deter RBI from cutting rates 25 bps in January, there's no reason why a slight increase to 10.9% should stop it. In any case, with services GDP finally starting to slow, it's reasonable to expect core CPI (ex-fuel and ex-food) to start slowing over the next 4-5 months—it took several quarters of slowing manufacturing GDP to get reflected in core WPI falling to a level where manufacturing firms have virtually no pricing power. The fact that the finance minister has promised a contractionary fiscal policy—0.4 ppt in FY14—also means WPI will further slow, though a lot depends on how the contraction in government spending takes place. If the FM gets his additional R50,000 crore from divestment proceeds and telecom auction receipts—in comparison with FY13—the R45,000 crore planned deficit contraction may not be that large, but if there is a slippage in the receipts, the contraction will be very real. The same applies to slippages in the optimistic 19% tax growth target—while FY13 tax collections grew well, this was on the back of a 2 ppt hike in service and excise tax rates, something that is not going to be repeated in FY14. While investment levels rising will boost GDP, the poor pricing power that India Inc has means inflationary pressures will remain dampened.
The joker in the pack, of course, is food inflation and the food security bill (FSB). In the past 4-5 months, the high levels of foodgrain with FCI meant that cereals WPI rose 17-18% yoy—since there will be even less grain stocks in the market once the FSB comes into being, the inflationary impact could be higher unless, unlike the PDS, FSB actually works in lowering consumer prices. A full-fledged FSB also means a higher deficit impact, so perhaps the government did well to postpone Monday’s decision on it till after the RBI policy later today. The cost/impact of the FSB, and the fact that one deadline on cutting diesel subsidies has just been missed, however is something RBI will factor in for the next policy, on May 3.