Healthy inflation declines are not enough

September 28, 2014 10:48 pm | Updated December 04, 2021 11:22 pm IST

As the Reserve Bank of India (RBI) gets ready to announce its fourth quarter bi-monthly monetary policy review on September 30, the usual expectations from the market for an interest rate cut are surprisingly muted. The surprise element lies in the fact that whatever data that are available in the public domain would seem to suggest a softer interest rate regime. According to this view, the RBI has, after a very long time, a favourable environment to lower the benchmark repo rate, which has remained at 8 per cent for the greater part of the year. The broad macro-economic indicators have generally been positive even though one ‘lead’ indicator — the index of industrial production (IIP) — continues to remain erratic.

Most significantly, inflation data for August — both retail and wholesale — have delivered big, pleasant surprises. Retail inflation based on the consumer price index (CPI) has declined by almost a full percentage point from July from close to 8 per cent to just above 7 per cent.

To give an even better perspective on the decline, the retail inflation number for August was almost 1.5 percentage points below the rate recorded in August 2013. However, while the fall in headline numbers is welcome, food inflation remains a cause for worry.

Food prices increased by 9.4 per cent in August over last year. Interestingly, this is lower than the food inflation rate recorded last year but is, nevertheless, a cause for concern. The inference is that food inflation remains high notwithstanding the fact that the rate of increase in food prices has come down.

The picture on inflation measured by the wholesale price index (WPI) is even more encouraging. Headline WPI inflation was 3.7 per cent in August, almost 1.5 percentage points below that of the previous month and the lowest recorded in almost five years. Another measure of the improvement: food inflation measured by the WPI index which was above 20 per cent last year (the rate of increase in food prices in August 2013 over August 2012) has come down to just above 5.2 per cent this year.

Not enough, says the Governor

Yet, not all the favourable circumstances seem to have impressed the RBI Governor, who in a well publicised statement in mid-September practically ruled out a rate cut. According to him, upside risks to inflation remain notwithstanding the recent softening.

For monetary policy purposes, the CPI, which has now replaced the WPI as the anchor, is on course to reach 8 per cent by January 2015.

But the RBI has more than once expressed the view that the target for January 2016 at 6 per cent might be more difficult to achieve. The main theme of the forthcoming policy statement is bound to be on why an interest rate reduction was so peremptorily ruled out weeks in advance.

There are two developments, which lend themselves to diametrically opposite interpretations. Food and fuel prices have for long dominated the inflation discourse and this time too it is not going to be different. The verdict on the recent southwest monsoon is not conclusive but initial reports suggest that the uneven spatial distribution has not had an adverse impact on food production. This probably explains the relative decline in food prices.

Second, global petroleum prices have come off their recent highs with the benchmark Brent falling by as much as $10 a barrel. Equally important, oil prices seem to be settling down at the lower price range.

Those who favour a rate cut rely on the more optimistic scenario in which food and fuel prices do not pose an immediate threat to the economy. On the other side, however, there are others who prefer to be cautious. The never-ending conflicts in West Asia have not had the feared dire consequences on oil prices. But the cautious approach would be to wait and see. A similar policy choice is predicated on how monsoons pan out.

The RBI’s monetary policy has traditionally involved a trade-off between meeting the needs of growth even while keeping a lid on inflation. Over all, recent policy statements when it maintained a status quo on interest rates, the RBI gave an assurance that the credit needs of the real sector, when GDP growth rates seemed stuck in the sub-5 per cent category, there was a clamour from various industrial bodies, chambers of commerce and even sections of the government, that the RBI should lower interest rates to boost industrial output.

However, as is well known, the RBI, under both Governor Subbarao and Governor Raghuram Rajan, stoutly resisted pressures arguing that unless inflation is controlled there cannot be any improvement in the macro-economy.

Tuesday’s bi-monthly review will, in all probability, explain why the RBI remains cautious.

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