In its mid-quarter monetary policy review, the Reserve Bank of India behaved with restraint, despite a near clamour for some form of easing. In line with our expectation, the central bank kept both the repo rate and cash reserve ratio unchanged at 8% and 4.25%, respectively. It was appropriate for RBI to ?wait? for any easing and not get tempted by either the recent moderation in headline and core WPI inflation, or the temporary buildup in liquidity pressures.
On the inflation front, clearly, the headline WPI inflation in October and November has surprised on the downside, as the pace of moderation was faster than anticipated, owing to the appreciation in rupee seen in September and October. WPI inflation has eased by 83 bps between September and November, with core WPI inflation registering a sharper drop of 124 bps in the same period, indicative of abating demand side pressures. More importantly, this has been accompanied by an easing of sequential momentum (defined as the three-month moving average of seasonally adjusted m-o-m changes) in both headline WPI (which reached a 10-month low of 0.47% in November) and core WPI (which reached a seven-month low of 0.29% in November) respectively. Despite the apparent moderation, two factors perhaps guided RBI to maintain a cautious stance ? across board inflation indicators do not project a similar inflation trajectory and preferred to establish the ebbing WPI inflation pressures by waiting another month, since there remain upside risks to WPI inflation
To augment our reasoning, CPI inflation has been gradually trending up, rising by close to 17 bps over the last two months. Both the headline and core CPI inflation continue to remain elevated, flirting with double digits. Besides, there still remains a part of WPI inflation which is suppressed on account of second round of electricity tariff hikes. Upside risks to WPI inflation also remain from rupee undoing most of its gains observed between September and October. PMI has already started showing buildup of price pressures, with both input and output prices rising in November after falling substantially in October. As such, there was indeed merit in RBI leaving rates unchanged and sticking to the previous guidance of incremental policy easing in Q4 FY13.
On the liquidity front, the current buildup in liquidity pressure has been due to a combination of advance tax outflows, coinciding with relatively large government balance. Since we expect this stress in liquidity to be temporary, with the quarter end, the government spending coming on board soon, we were of the view of no CRR cut, which is currently at a multi-decade low. Going forward, in my opinion, RBI is likely to calibrate liquidity conditions in accordance with the spending pattern of the government, by using open market operations.
Here on, we expect the moderation in headline inflation to continue steadily, barring December, with WPI inflation easing to 7.25% by March 2013 (below RBI projection of 7.5%). On other hand, growth shows incipient signs of bottoming out, as also validated by YES BANK demand conditions index. While growth in Q3 is expected to remain sideways, it is likely to clock above 6% in Q4. For FY13, we continue to retain our GDP growth forecast at 5.7%, and expect it to improve to around 6.5% in FY14.
The moderation in inflation accompanied with the supply side measures initiated by the government, are likely to serve as ?growth enabling conditions? paving way for further monetary policy support to growth. As such, RBI is expected to begin easing as early as January 2013 and cumulatively cut repo rate by 50 bps until March 2013 and by an additional 50-75 bps through FY14.
The writer is chief economist, Yes Bank
