Repo rate cut: What's holding back RBI

In line with expectations, Reserve Bank of India (RBI) kept the policy rate unchanged and the policy stance neutral given the upside risks to inflation. The upside risks to inflation remain either elevated or have gone up given the loan waivers, the states' implementation of the Pay Commission allowances and the price revisions following the launch of the Goods and Services Tax (GST).

Moreover, the spatial distribution of monsoon poses a serious concern as far as inflationary expectation is concerned. Besides, insufficient rainfall in some regions has led to lower water levels in India's 91 main reservoirs, putting winter crop at risk. On the other hand, benefits of low commodity prices till last year may not be available this year.

While the recent cut in retail prices of petrol and diesel is a welcome step from the inflation standpoint, it will take a few months before it shows in the inflation numbers. Both consumer price inflation and wholesale price inflation have gone up due to increasing food inflation, waning base effect and growing inflation in fuel and power sectors. The likelihood of lower output of rice, maize, soybean, groundnut, tur and moong dal, along with rising global crude oil prices, would keep inflationary expectations elevated.

On the growth front, the back-to-back structural and disruptive reforms such as demonetisation and GST have impacted the economy. Both these reforms will have a long-term positive impact on the economy, but they have hit GDP in the short term and are causing uncertainty, particularly in the cash-dependent informal economy.

RBI has already reduced the gross value added (GVA) growth projections from 7.3 per cent to 6.7 per cent, citing the adverse impact of GST, concerns around Kharif crop production, weak consumer confidence and delay in investment. Further, the triple balance sheet problems - the strain in the corporate balance sheet, stressed assets in the banking system and the pressure on public finances - have the potential to delay any investment activity in the economy.

Moreover, lower capacity utilisation rate and subdued demand will put an additional burden on investment revival. While growth is unlikely to deteriorate further, the pain is expected to continue for the next few months. Although the implementation of the seventh Pay Commission award is likely to provide some respite to overall consumption, any contribution from investment is likely to be limited in the current year.
 
On the monetary side, previous rate cuts are yet to be reflected in the lending rates proportionately. Upward risks to inflation due to expectations of lower farm output, likely rise in global crude oil prices, depreciating currency, implementation of the seventh Pay Commission award, expectations of Fed rate hike and the impact of GST on the overall pricing structure are expected to define the factors for RBI to consider any policy alteration in the future.

However, it is unlikely that RBI will consider any rate cut during 2017. Given that rate cut is unlikely in the near future and investment demand could be delayed, the government and the RBI should work in tandem towards achieving some targeted goals to boost the growth momentum.

The writer is lead economist at Dun & Bradstreet, India