In the run-up to the Reserve Bank of India’s mid-quarter credit policy announcement, recent economic news obviously counts. Whether there will be a rate cut or not — a source of perennial and often unproductive speculation incidentally — will depend partly at least on how the central bank reads the economic data. Inflation data obviously count but so do the monthly Index of Industrial Production (IIP) data. Other than this, the statements of the Governor and other senior central bank and government functionaries will be closely watched for what they mean for interest rates and the macro-economy.

Factoring in the slowdown

Obviously, at a time of slowdown like this, with economic growth during the first quarter coming at under 5.5 per cent, the central bank’s views on the macro-economy should matter far more than a discussion on interest rate cuts, even if the two are related. The RBI’s current forecast of gross domestic product (GDP) growth for fiscal 2012-13 is 5.8 per cent.

Last Wednesday, the Central Statistics Office released the industrial output figures for October, which showed the IIP at a 16-month high of 8.2 per cent on a year-on-year basis.

It is only the third time in the first seven months of the fiscal year that industrial output figures have gone up. In October, industrial output had contracted by 0.7 per cent. The unexpectedly high industrial output numbers for October have given rise to optimism in government circles. The Finance Minister, P. Chidambaram, sees in the figures “green shoots” of economic recovery. Many others, however, are less sanguine.

The output figures have, to a large extent, been bolstered by the base effect: last October industrial production had contracted by almost 5 per cent. Certain important segments such as capital goods have posted respectable growth of 7.5 per cent. Here again, the base effect is at play as last October (2011) saw a sharp decline in this segment. Overall industrial growth during the April -October period has been low at 1.2 per cent compared to 3.6 per cent in the corresponding period last year.

But the base effect alone does not fully explain the pick-up in the IIP data. What has made a significant difference is the jump in the long dormant manufacturing sector and the surprising double-digit growth in the consumer goods sector. Like the overall IIP numbers, consumer goods too had contracted in September. However, even after discounting the base effect, it is possible to see some positive trends.

That is what the Chief Economic Adviser Raghuram Rajan was referring to when he said that economic growth seems to be stabilising with the government’s recent steps expected to strengthen the recovery further. The key question is whether the better sentiment will be reflected in the forthcoming policy actions, including the monetary policy statement on December 18.

A high IIP growth should theoretically lessen the clamour for an interest rate cut. If industrial growth had indeed revived, the RBI can remain focussed on its key objective of inflation containment. Yet, as pointed out, the IIP bounce-back might be illusory. Sustainable industrial growth might be still some distance away.

Moreover, if the industrial production figures raised hopes of a recovery, the retail inflation numbers which came in on the same day are a source of concern. Retail inflation rose to near double-digits, 9.9 per cent in November from 9.75 per cent in October.

Although it is the wholesale price index (WPI)-based inflation that the RBI relies upon, the newly introduced Consumer Price Index (CPI) has also to be reckoned with.

A complicated picture?

In the event, the announcement on Friday of November WPI inflation at 7.24 per cent, lower than the October figure of 7.45 per cent further complicates the picture.

Export figures released last week present a dismal picture. The government is thinking of providing incentives to exporters. But a revival in international trade would begin only when there is an improvement in the economies of the European Union and the U.S. India’s integration with the rest of the world has never before been as clear as it is now.

It is certain that the monetary policy statement will mention this fact. Specifically, the decision of the U.S. Federal Reserve to hold on to current very low interest rates has major implications for India. Excess global liquidity can check global commodity prices. Large capital flows might head towards India and other emerging markets. Anecdotal evidence suggests that it is already happening here.

However, that need not be a win-win situation. Short-term capital flows can be destabilising. They can reverse course whenever their perceptions of risks change. The stock markets might be pushed upwards to unsustainable valuations, only to return to “normal” levels when the foreign institutional investors and portfolio managers change direction. All in all, look to tomorrow’s policy statement for what it says on the macro-economy and its global linkages. As for specific monetary action, the betting is on a CRR cut and that too mainly to mollify those arguing vigorously for a rate cut.

By January next, the RBI has hinted that it might begin to ease interest rates. Hopefully, it will have clearer economic data to support its action.


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