In just two months, the Reserve Bank of India (RBI) has brought back rate cuts on the table, after categorically stating that they were off the menu. RBI governor Urjit Patel, in a press meet, said that if the upside risks to inflation do not materialize, then the monetary policy can change accordingly. Bond markets have already gained following his statement and yields dropped 10 basis points.
One basis point is one-hundredth of a percentage point.
Indeed, nothing in the resolution statement, fashioned by the six-member monetary policy committee (MPC), indicates that policy rates will be hiked in the near term. In fact, the committee seems to have realized its folly of changing the policy stance to calibrated tightening in October. Of course, the stance was not changed on Wednesday. But in all respects, it was rendered useless and made into a neutral one by Patel’s statement on potential rate cuts.
The backdrop in which the MPC voted on policy rates on Wednesday is markedly different from what it did during the voting in October. Oil prices are 40% lower now, the rupee has gained 5% since October and economic growth has slowed marginally. The biggest swing factor is of course the drop in domestic inflation.
RBI has found that headline inflation will yet again undershoot its forecasts. Therefore, the central bank has cut projections for the second time, and expects headline inflation to rise to 3.2%, at best, by the end of FY19. This means that the MPC has successfully achieved its 4% inflation target for FY19.
Much of the credit goes to the collapse in food prices, despite the government promising higher minimum farm prices to growers. With food in deflation, the effect of firming demand for other discretionary items has been offset to a large extent. Add the recent sharp fall in global oil prices, and the outlook for benign inflation gets cemented.
But, it would be a folly to expect a rate cut with near certainty.
The central bank thinks that food deflation is too good to last long, and it is not entirely wrong. Prices of perishables tend to bounce back fast; besides, rabi—or winter—crop sowing has been lower than last year. Global crude oil prices are anyone’s guess.
It is obvious that RBI is befuddled like the markets on oil prices. Hence, it hasn’t let go of its fear of a bounce-back in both food and fuel. Further, core inflation is uncomfortably high and, unless the improved investment momentum doesn’t manifest into better supply of infrastructure and services, core inflation is here to stay.
Given that 2019 is an election year, demand pressures typically seen during electoral polls would also queer the pitch for RBI rate cuts.
RBI believes that domestic growth will be 7.4% as several indicators point to a pickup in growth. Latest Purchasing Managers’ Index shows that demand is robust. RBI’s own survey on business expectations also shows growth prospects are better than before.
Ergo, RBI won’t cut rates without making the economy sweat for it.