Close call for RBI as inflation not in comfort zone yet

Tags: Policy

All eyes on bank’s mid-quarter money policy review tomorrow

The Reserve Bank of India (RBI) continues to worry about inflation as it prepares to unveil its mid-quarter monetary policy on December 18 amid a clamour for cutting rates to fuel growth.

So far, the central bank has stuck to guarding inflation as its main responsibility, even at the cost of declining suggestions for an easy money policy from finance minister P Chidambaram who has been pressing for lowering the cost of capital to stimulate investments.

So, will the RBI oblige the finance minister this time round, or will Chidambaram continue to tread the lonely path to accelerate economic growth?

Central bank watchers and mavens believe the RBI may wait for inflation to soften on a sustained basis before cutting rates, though they broadly believe that there may be easing of liquidity by way of a cut in the cash reserve ratio (CRR) or money banks have to compulsorily park with the central bank as reserves.

For the RBI, it will still be a close call as it weighs all macro-economic factors before deciding which way it will finally tilt. “The print on core wholesale price index (WPI), coupled with recent reforms give an outside chance of the RBI again surprising markets in its review on December 18,” says Rohini Malkani, economist with Citi in a note.

The WPI was down for the second consecutive month at 7.2 per cent, lower than the general expectation of 7.68 percent, while core inflation at 4.5 per cent is at a three-year low.

This is closer to RBI’s comfort zone of four per cent. But the consumer price index (CPI) was close to double digits at 9.9 per cent and is a persistent source of concern.

Doubts are raised that the RBI may not act yet in cutting rates, and will take a turnaround stance only in January. Abheek Barua, chief economist HDFC Bank, said, “We hold on to our view that RBI will cut rates only in January, but they may go ahead with a cut in the CRR to give a permanent solution to the liquidity conditions. They had given a guidance that in January they would get room to reduce rates if inflation eased. To give credibility to their analysis, they may stick to their guidance. But to ease liquidity, RBI may give a more steady assurance by cutting the CRR.”

In his note, Malkani of Citi, states: “RBI is expected to ease repo rates by 50 basis points in the January-March quarter. This is in line with RBI’s guidance in policy, headline inflation over seven per cent, and the CPI at near-double its October digits.”

The big surprise came in the index of industrial production (IIP) data for October, which showed an 8.2 per cent jump led by a year-on-year growth of 9.6 per cent in manufacturing and 16.5 per cent in consumer durables.

Deepali Bhargava, chief economist at Espirito Santo said, “The main surprise came from the latter and not from the capital goods side (which grew at 7.5 per cent year-on-year), something which suggests that the big jump in IIP is more seasonal demand-related than any incipient turnaround in investment. It is unlikely that RBI will deviate from its guidance of a rate cut in the fourth quarter of 2012-13.”

Growth in consumer durables, at a 20-month high, benefited from a very positive base-effect. The fact that ‘core’ IIP growth (excluding capital goods’) was also high at 8.2 per cent year-on-year shows that consumer goods had a big role to play in the IIP growth number.

“We strip-out the seasonal impact to see the real trend growth. Our preferred momentum indicator (seasonally-adjusted three-month moving average) reveals that consumer durables’ growth improved marginally (two per cent year-on-year), rather than the huge jump as suggested by the headline growth in consumer durables.

The fact that automobile sales slumped again in November 2012 (1.3 per cent YoY v/s 13 per cent in October) supports the view that the jump in this segment is unlikely to sustain. Erosion in purchasing power, on account of persistently high inflation and interest rates, is denting discretionary spending,” Bhargava said.

Upansa Bhardwaj economist at ING Vysya, summed it up thus: “Besides maintaining liquidity within comfortable levels, we expect RBI to undertake growth-inducing measures in Q4-FY13 as the inflation trajectory begins to ease. Even as inflation would continue to remain above comfort zone, we expect RBI to cut the repo rate by 50 bps in the last quarter to stimulate investment activity.”


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