When RBI declared the fifth bi-monthly monetary policy statement on December 2nd, Rajan chose not to change the key policy rates. The markets anticipating a rate cut were disappointed. However, the statement that “rates can be cut outside policy review cycle” was taken as a signal of rate cut sooner than later.
The rational explained in the policy statement showed that RBI is still not sure about the final downturn in the inflation. The current decline in consumer price index is thought to be based more on base effect as well as seasonal changes in prices. RBI expects inflation to go upwards since December once again thus justifying the need to continue the high policy rates for some time.
RBI has repeatedly made it clear that it does not want to change stance abruptly if the inflation brings up its head again. When it will start to cut policy rates, it will be a signal that inflation has finally started cooling down in India.
Though it might appear that this is a rational stance taken by a central bank, this kind of risk averse position has ignored many other factors. The data released between 12th to 15th December after the monetary policy was declared has only emphasized the worsening economic situation. Index of Industrial Production (IIP) for October has fallen by 4.2% and manufacturing has contracted by a sharp 7.6%.
In fact, consumer durables segment has fallen by an unprecedented 35%. Whole Price Index (WPI) for November has reached a record low of 0%. GDP growth rate has come down to 5.3% in Q2 from 5.7% in Q1. Again, manufacturing GDP growth rate has come to a halt from 3.5% in Q1 to 0.1% in Q2. Except trade, hotels and transport sector, there is no sector in the economy which has recorded higher growth rate compared to previous quarter.
There is a clear glut in the market with deposit growth being consistently higher than the credit growth. Capacity utilization has fallen to 70% according RBI’s own quarterly order books, inventories and capacity utilization survey (OBICUS). Though new investment in projects is rising, the value of projects being dropped is consistently high for last 4 quarters showing that there is no real pick up in investments.
With such bad news pouring down from all directions in the economy, it was really crucial for RBI to lower interest rates and to signal the beginning of accommodative monetary policy.
RBI’s assessment of inflation also looks more defensive. With better expectation of Rabi crop for coming season, food inflation is expected to cool down.
With no real demand in the economy and supply gut, the wholesale and consumer inflation cannot shoot up.
Falling crude oil prices will only help softening the prices further. Fiscal deficit seems to be under control.
Though tax revenue collection is obviously a matter of concern due to shrinking economic activity, falling fuel subsidy burden has provided a much needed cushioning. Hence, either a fiscal deficit induced or higher fuel cost induced inflation is not a worry anymore.
In the external sector, current account deficit (CAD) has widened to 2.1% of GDP or USD 10.1 billion in Q2. However, foreign exchange reserves are at comfortable level and depreciation in rupee should not provide an excuse for keeping policy rates high.
