RBI policy: Current inflationary environment does not allow for a rate cut

The Reserve Bank of India's six-member Monetary Policy Committee is set to meet on December 5-6 for the fifth bi-monthly policy review. The central bank is unlikely to change repo rate. Some bankers and economists are also expecting status quo on repo rate. This author discusses why the RBI should not cut rates right now.

RBI had maintained status quo on policy rates in its last review. It cited risks due to higher inflation, largely emanating from rising crude oil prices, uneven distribution of monsoon and amplified global geopolitical uncertainty. Other factors included increased volatility in financial markets as the US Fed unwound its balance sheet and domestic fiscal challenges.

Not much has changed since.

The upcoming RBI Monetary Policy Committee (MPC) bi-monthly meeting on 6th December will assess some of these factors before settling on new rates and direction. But any real change can safely be ruled out given the unchanged background. However, it’s not totally an open and shut case and there are some points worth considering.

RBI’s efforts in controlling inflation over the past several quarters have been largely successful. However, CPI inflation at 3.6% in October 2017 is a 7-month high, essentially driven by food and fuel prices. Farm produce prices are showing an uptrend after hitting two-year lows on the back of record production and two good monsoon years. As the lingering impact of demonetisation fades and the economy gathers pace, this could indeed accelerate. Crude oil prices too have strengthened by more than 10% since the last monetary policy and continue to show potential to rise further, impacting our import bill significantly. While the rise in inflation has been along its expected trajectory so far, this uncertainty will hang heavy on RBI’s decision.

On the other hand, with the first half year IIP growth dropping to 2.5% year-on-year from 6% in the year-ago period, there have been expectations and demands to cut interest rates and help lift the economy. To counter this, RBI in its last policy had signalled that other non-monetary measures like recapitalisation of PSU banks, infrastructure spending, reviving stuck investment projects, quicker rollout of affordable housing schemes, simplification of GST, etc. should be activated to spur growth. And the government has moved remarkably fast on many of the recommendations which will give a fillip to growth, perhaps without a rate cut.

Given the overall scenario, we expect the RBI to be consistent with its inflation (4.2%-4.6% in 2HFY2018) and growth (GVA growth at 6.7% for FY18) expectations. Risk of inflation, especially from crude oil prices, will continue to draw emphasis and be a major factor. A hike is not at all warranted. Therefore, we envisage that the RBI will maintain status quo on policy rates as the potentially inflationary environment does not allow for monetary easing at this point.