With RBI scheduled to review its monetary stance next week, a Reuters poll showed all but three of the 52 economists polled expect RBI to stay on hold on June 3. That?s probably a fair prediction. There is hardly a case for RBI to relax its stance at this point on grounds of inflation, even as it is anxious about growth. Besides the resurgent consumer price inflation last month, the central bank is confronted with a number of unknowns at this point. These factors suggest a deferment of any monetary action two months hence.
First, headline CPI rose in April?to 8.6% from 8.3% the previous month?from higher food prices. Core consumer inflation was pretty much unchanged though. That is hardly any comfort to RBI. Although the fall in underlying momentum may be reassuring, indication that demand pressures are declining too slowly tie the central bank?s hands. Wait-and-watch is warranted from another perspective too, viz., lagged spillovers of higher food prices. Recent research from the IMF shows that headline inflation soon passes through to core prices. Add to this the risks from a 5% below-normal monsoon forecast by the weather department. Any relaxation on inflation front can be excluded therefore.
That apart, at least three factors with significant bearing upon price developments are unknown as yet. One, the government is yet to announce minimum support prices (MSP) for agriculture this season. While some increase must already be factored into RBI?s inflation projections, it is not known if these may be exceeded under a new regime. Two, any changes above the ongoing reduction in the administered-market prices? gap in fuels are not clear so far; should the government chose a faster pace, or one-time elimination of subsidies, remains to be seen. Three, the budget is yet to be presented by the new government, so RBI cannot factor in the fiscal stance into its reaction function at the moment. It isn?t known if much-needed fiscal space to increase capital spending for stimulating growth will be created by switching expenditures (from current to capital spending) or a temporary breach in planned fiscal targets. RBI will have to wait for clarity on the fiscal side.
What might it say on growth? It will note the weakness, particularly with reference to January-March GDP (due today) growth, which is likely to be 4.8% year-on-year against 4.7% previous quarter, according to consensus estimates. The central bank?s discussion of near-term recovery prospects will take into account that industrial output growth contracted at a slower pace in March; that non-oil, non-gold imports also contracted at a slower pace in April; that export growth recovered to an unexpected 5.3% y-o-y in April, after a two-month consecutive contraction; that April manufacturing Purchasing Managers? Index (PMI) remained unchanged at 51.3, while the services? PMI eased a bit to 48.5 from 47.5 in March, but remained in the contraction zone for the tenth consecutive month. Supplementary leads on economic activity from RBI?s own OBICUS (Order Books, Inventories and Capacity Utilization Survey), industrial outlook and consumer confidence surveys will be added to these stabilisation signs to gauge the outlook for growth ahead.
RBI will be pleased, as much as possible for any central bank to be, with the sharp turnaround in the current account deficit, to 1.7% of the GDP in FY14 from 4.7% last year, and caution nonetheless about resurgence in imports with any near-term recovery in demand. Likewise, the buoyancy in capital flows will be noted too, along with ample liquidity from the enhanced foreign currency supply. The punch will be taken away however, by concerns about increased financial volatility risks from possible corrections in asset prices. Prudence on the external environment will be underlined too?an uncertain, uneven global recovery relative to its last review, wherein the US, UK and Japan are doing alright, but slowing China and deflation-prone Euro area are raising the risks, while the significant adjustments in emerging market economics are making them grow slower in the process.
Here is what we wish it talks more about: The elasticity of link between monetary policy, i.e., the repo rate, and economy-wide inflation expectations; how it sees the beliefs of rural wagers, the key source of inflation and its expectations, shaping in response to pre-announced and committed inflation targets, including the role and responsibility of government in this regard; the conflicting pulls exercised by further infrastructure expenditure (as contemplated) and existing scarcities in goods and services that underlie relative price pressures; and much else related to all this.
Finally, what are the prospects for interest rate cuts ahead? Consider in this context the possible evolution of food prices and their potential to influence inflation expectations, wages and core consumer prices. Assume resumption of investment demand, especially infrastructure, and associated uplift in labour demand as job opportunities are created in that process. Is there a threat to the downward trend in real wages, in the absence of any supply-side resolutions? Even if constraints were to be relieved, the effects will play out with a lag. The direction of interest rates is more headed up than down, one would think.
The author is a New Delhi-based macroeconomist
