Indicates rate cuts if govt lives up to its promises
Though the usual imponderables—El Nino, action on MSP, fiscal deficit—remain as they do at the time of any policy, the central bank did well to extend a hand to the new government which is trying to revive growth while keeping a lid on inflation. In sharp contrast to earlier RBI communications—at the time of Governor Duvvuri Subbarao and finance minister P Chidambaram for instance—this time around, RBI has taken the government’s stated intentions/manifesto-promises on board and gone and announced a relatively dovish statement of policy intent. RBI has not cut policy rates, but it has eased liquidity by cutting the SLR 50 bps and, more important, signalled room for a rate cut a few months down the line “if disinflation, adjusting for base effects, is faster than currently anticipated”. That doesn’t necessarily mean rates will be cut—indeed, the ‘adjusting for base effects’ means just the expected June to November fall in inflation due to just the base effect won’t be taken into account. But since RBI talks of the possibility of stronger government action on food supply, this means it is confident the government will dump wheat and rice stocks from FCI to kill foodgrains inflation; RBI seems to be more sure about better fiscal consolidation this time around, something finance minister Arun Jaitley has talked about.
Steps on increasing the foreign exchange Indians can take out under the Liberalised Remittance Scheme are welcome, and expected given the inflow of dollars, though a cautious RBI has still not gone all the way back to the earlier $200,000 per year and kept the new limit at $125,000. Cutting back on export credit and moving the money to the more general lending window is also a step towards less fractured credit markets.
Given the slow growth for the third year running, especially the collapse in FY14 ex-agriculture GDP—manufacturing contracted on top of stagnant FY13 number—a convincing case could certainly have been made for a rate cut. More so since, at 5.9% for FY14, headline WPI inflation is well within RBI’s comfort zone. Given the low levels of capacity utilisation that you see in the RBI surveys regularly, it is a fair bet that manufacturing inflation is not going to be rising in any serious manner. In even the case of CPI, though core inflation levels remain relatively sticky, the worst seems to be over. At 8.6% in April, headline CPI inflation is off its 11.2% November peak—around a seventh of this is due to fruits and vegetables alone, items that interest rates have no control over. In the absence of a serious drought, it is possible inflation levels may come off enough to warrant a rate cut a few months down the line. In which case, it will be important to see whether, over the next couple of weeks, the government raises MSPs dramatically since this will spur inflation—the CACP recommendations are moderate ones, but the BJP’s manifesto has some worrying suggestions. A lot will also depend on whether Jaitley compresses the deficit—ultimately, it is the borrowing target that will lower/hike interest rates. If the budget moves away from the usual MSP-based farm interventions to area-based subsidies, that will also give a fillip to fruits/vegetables production and lower inflation. It is over to the government now.