The central bank’s monetary policy stance continues to baffle, and not just because it is not clear how RBI expects to see rate cuts by banks in a liquidity-constrained situation. In earlier policies, the RBI’s talk has been different from its walk. This time around, including in Thursday’s pre-policy macro statement, a hawkish RBI has talked of limited room for cutting rates. Friday’s monetary policy statement talks of upside risks to inflation being significant in the near-term and says RBI will try to keep March 2014 inflation down to 5% “using all instruments at its command”—so while analysts are talking about a further 50 bps easing during the year, RBI is even hinting at hiking rates since it is likely WPI in March FY14 will be at least 1-1.5 percentage points higher than 5%. The problem with this hawkish statement is that it is accompanied by dovish facts. After projecting a 5.5% GDP growth for FY13, RBI’s base case for FY14 is a flattish 5.7% which is lower than the PMEAC’s 6.4%. Global growth, according to RBI, is patchy with US recovery looking like it is taking hold but Europe still in the doldrums; growth in China, Russia and India continues to be below trend. Look at almost any indicator you like, and it reflects precisely this—India’s PMI, RBI quotes, is at a 17-month low, GDP is at a 15-quarter low. Which is why global commodity prices have softened and which is why India’s WPI is at a 40-month low. So what is the significant upside risk to inflation?
RBI is obviously right to worry about “demand-supply imbalances, the ongoing correction in administered prices and pressures stemming from increases in minimum support prices”, but some perspective is required. The latest CACP recommendation on paddy MSP is for just a 5% hike. Diesel prices, it is true, are being raised each month, but this is accompanied by a fall in prices of other products like petrol which are linked to global prices—between January when diesel prices were first hiked dramatically and March, while the fuel sub-index of WPI rose from 9.3% to 10.2%, overall WPI fell from 7.30% to 5.96%. To the extent the government is talking of coal price-pooling, or even coming up with a restructuring programme for distressed SEBs, this is aimed at easing supply constraints which will lower price pressures.
In which case, RBI’s biggest fear stems from the current account deficit (CAD) and, more specifically, the value of the rupee. There is little doubt the CAD is still too high and it is not just gold, items like coal imports have also become significant. But the fall in gold prices should help contain the CAD a little. The other fear is that, at some point, fed up with the government not able to fulfil various reforms promises made, FII and FDI will slow, putting pressure on the rupee and therefore on inflation. With FII inflows slowing in March and April, the rupee has weakened, but not by that much. In January when FII flows were $4.7 billion, the rupee was at 53.3 to the dollar; in February when FII rose to $4.89 billion, the rupee went to 53.8; in March, FII collapsed to $2.83 billion and took the rupee to 54.4; in April, FII flows were $2.46 billion but the rupee was at 53.94 on Friday—in any case, the appetite for debt inflows seems very large right now. As a central banker, RBI needs to be cautious, but its inflationary fears appear a bit heightened.