A cautionary note

Reserve Bank of India Governor Raghuram Rajan has opted for caution, citing the uncertainty surrounding the future trajectory of inflation and signs of an upside bias to expectations. In leaving interest rates unchanged while retaining an “accommodative” monetary policy, he has chosen to leave all options on the table and wait to see how various global and domestic factors pan out. That the RBI has opted for watchfulness, notwithstanding the prospect of an “above normal” and well-distributed monsoon that has the potential of being “a source of disinflationary pressure”, is testimony to the central bank’s concern about keeping inflation expectations well-anchored. Consumer price inflation posted a surprisingly rapid acceleration to 5.39 per cent in April on the back of a more-than-seasonal jump in the prices of food items including vegetables, fruits, sugar, meat, fish, pulses and edible oils. Separately, international prices of commodities have started to strengthen, including that of crude oil; this has begun feeding through into higher transport and communication costs. The overall impact of these trends has been that the inflation expectations of households, projected three months ahead, moved up marginally in May after the previous survey had shown a decline. And the elephant in the room is the anticipated implementation of the Seventh Central Pay Commission’s recommendations: to what extent the increased payouts will fan inflation has yet to be quantified, and will ultimately depend on the Centre’s timetable for implementation.

The RBI has also flagged the challenges to sustaining India’s economic momentum: global growth is uneven and struggling to gain traction, world trade is floundering for want of demand, the U.S. is weighed down by contracting industrial activity and exports, deflationary pressures are building in Japan, and the slowdown in China shows no signs of reversing. Besides, if Britain votes to leave the European Union, there is a real risk of “some turmoil in the financial markets”, according to Dr. Rajan, who added that the RBI is armed with adequate reserves to weather any volatility that may emerge. On the domestic front, green shoots are visible on many fronts. Cargo traffic at major ports, commercial vehicle sales, cement output and steel consumption are leading an upturn that point to a more broad-based expansion. The RBI’s own surveys reveal healthier order books and a pick-up in capacity utilisation that can help trigger a revival in private investment. Ultimately though, a lot will hinge on how the monsoon fares, and how much the Centre is willing to invest by way of capital to bolster public sector banks. The central bank, in the end, can only do so much.