The RBI’s pause is in order as inflation is a heady mix of structural and cyclical factors
As expected, the RBI in its first bi-monthly monetary policy statement for 2018-19 kept the policy rate unchanged at 6 per cent. Also, the tone of the policy commentary suggests that despite several uncertainties surrounding the inflation trajectory, the RBI is not in a hurry to either change the policy rate or its neutral stance on monetary policy.
While assessing various aspects of the economy, the RBI seems to be comfortable with the overall growth outlook for 2018-19 as also with the ongoing momentum witnessed in the agricultural and industrial sectors.
With the total food grain production estimated to touch 277.5 million tonnes and horticultural production touching a record 305.4 million tonnes in 2017-18, coupled with the IMD predicting a normal monsoon in 2018, the central bank seems less worried about food inflation flaring up due to supply shocks.
Also, recent data suggests that in terms of quarterly performance, industrial expansion set in the second quarter has spilled over to the third and fourth quarters of 2017-18.
The RBI sees this as an indication that industrial recovery is finally gaining traction. This is further corroborated by its latest industrial outlook survey which shows improvement in business sentiment driven by increase in new orders.
Despite the expansion of economic activity, the RBI also seems to be comfortable with respect to the availability of liquidity in the system, although liquidity has been alternating from surplus to deficit in the last two months.
However, the central bank kept a close watch on the liquidity and managed to keep the weighted average call rate (WACR) within the LAF corridor. WACR during January, February and March 2018 was 12, 7 and 5 basis points lower than policy rate, respectively.
Notwithstanding the aforesaid, the RBI expects a number of domestic and global factors to pose risk to the inflation and inflationary outlook.
On the global front, intensification of a tariff war could adversely impact the world trade volume, which otherwise has been robust in the first quarter of calendar year 2018, according to data on container trade throughput, air freight and export orders.
Oil prices, after remaining soft in February 2018, have again started hardening since the second half of March 2018. The pace of normalisation of US monetary policy has made global financial markets volatile. This has led to depreciation of emerging market currencies.
On the domestic front, revised MSP announced in the Budget, staggered impact of HRA revisions by various State governments, another round of fiscal slippage both at the Central and select State governments, and increase in industrial input and output prices can pressure inflation. However, the RBI is hopeful of CPI remaining 4.7-5.1 per cent during 1HFY19 and 4.4 per cent in 2HFY19.
If the RBI sees inflation broadly remaining in the comfort zone over fiscal 2019, and CPI inflation lately has come in lower than the RBI’s projection, why is the RBI still in a pause mode? As policy-making is more about remaining ahead of the curve, the RBI, on the basis of its assessment and projection, should perhaps have gone for a rate cut. It is easier said than done because inflation projection is not an easy task. In the context of India, it is even more arduous because the food component carries a higher weight in retail index and is also highly volatile.
However, since the average inflation has remained within the band of 4 per cent corridor since fiscal 2015, there is a growing belief that, structurally, inflation has moved to a lower band and therefore the RBI’s persistence on the side of caution is hurting growth recovery. In a supply-constrained economy like ours, it is still too early to believe that structurally we have moved to a lower band of inflation. Inflation in India is such a heady mix of structural and cyclical factors that at what time, which one will play out with what intensity, is difficult to predict.
A number of times in the recent past, spikes in select food items have reversed the expected inflation trajectory. Moreover, average inflation remaining in the comfort zone of the RBI since fiscal 2015 has a lot to do with the collapse of global commodity prices.
Therefore, against the evolving growth-inflation dynamics, the RBI’s preference to be on the side of caution, in my view, appears to be the right stance, and we are in for an extended pause on the policy rate.
The writer is Director and Principal Economist, India Ratings and Research