That, above all, will decide RBI’s inflation stance
It is just as well that the largely media-created hype over likely strained relations between RBI and government have been put to rest by finance minister Arun Jaitley and RBI Governor Raghuram Rajan’s co-ordinated statements on growth and inflation. But that still doesn’t leave us any the wiser over what RBI policy will be over the year. Certainly there will be a pause on Tuesday since there are still too many imponderables. Barring fruit and vegetable prices, both CPI and WPI inflation look more comfortable, but with freak weather right now and a possible El Nino-induced drought, it may just be a matter of time before food inflation starts becoming a serious problem again. More important, while the role of interest rates in stimulating investment is positive, this is not the binding constraint at the moment. That remains India Inc’s excessive leverage as well as the banks’ under-capitalisation. While it remains to be seen whether the government will address this, as well as the larger question of autonomy for PSU banks, the other data point RBI needs to wait for is the budget. Will a fiscal correction be announced and, if so, how credible will it be—the last two budgets have seen dramatically high taxation numbers being projected even in the face of slowing/declining economic growth forecasts. The lack of clarity over the fate of PSUs also casts a shadow over the budget—since the prime minister is convinced PSUs can be turned around, it is not clear how much money the budget will allocate under this head.
But assuming projects start getting cleared, stuck up capital will get released and things will slowly start looking better; more so if India Inc uses the current bull run to raise more capital to repay debt as also to sell some assets. The elephant in the room, though, remains the Urjit Patel report and the sooner Jaitley addresses this, the better. Whatever the view on tackling inflation, RBI policy actions will be dramatically different if the Patel recommendations on inflation-targeting are accepted and, whether or not they are, whether India is junking the old WPI peg in place of a new CPI one. Apart from the serious doubts expressed over the credibility of the index which has remained unusually sticky though WPI hasn’t, some basic maths is worth keeping in mind. If food inflation stays at its 10% average over the past 8 years, a 6% CPI-inflation target means non-food inflation has to come down to 2%; and a 4% inflation—Patel’s long-term target—requires this to come down to minus 2%. In other words, accepting the Patel report heightens the chances of a tight monetary policy.