Despite headline inflation falling to its lowest level in 12 months, owing to a contraction in factory output, economists said the central bank would not resort to a cut in the cash reserve ratio (CRR) when it meets to review the policy on Friday, but would opt for open market operations (OMOs) to tide over the liquidity crunch.
Wholesale price index-based annual inflation rose 9.11 per cent in November, compared with 9.72 per cent in October, primarily due to the statistical impact of a higher base. Noticeably, the headline inflation for September was revised to 10 per cent from the provisional 9.72 per cent. The revision to double digits was seen after a gap of 14 months.
Abheek Barua, chief economist, HDFC Bank, said, “Given today’s inflation release, it is unlikely that the Reserve Bank of India (RBI) would opt for a CRR cut when it meets this Friday for its mid-quarter review. Instead, it would focus on using tactical measures such as OMO buybacks to ease the recent drag on liquidity.”
Today, banks borrowed about Rs 80,000 crore from RBI’s repo window. This is above the central bank’s comfort zone of +/- 1 per cent of net demand and time liabilities.
According to RBI estimates, headline inflation would cool to seven per cent by March. Economists said RBI may not be in a hurry to change its stance from an anti-inflationary one to a pro-growth one, though inflation’s current trajectory is expected to sustain. “Despite the moderation in November, inflation, especially core inflation, continues to remain significantly above RBI’s comfort level. With core inflation also coming under pressure because of rupee depreciation, we believe the anti-inflationary stance of the central bank would remain intact,” YES Bank said in a research note. “We believe OMOs would be the preferred route for RBI to alleviate the liquidity stress in the economy, rather than a cut in CRR, since CRR is essentially a monetary policy tool, not a liquidity tool.”
A pro-growth stance is expected to be adopted only next month, when the central bank would meet for the third quarter policy review on January 24.
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“With growth slowing much more than expected and the likelihood that headline inflation could cool to seven per cent by March, the central bank is, however, likely to build in a dovish rhetoric in its monetary stance, leaving the door open for a possible CRR cut in January and a repo rate cut in the first quarter of FY13,” Barua said.
Economists said RBI’s decision to adopt a pro-growth approach would be complicated, as inflation and wage expectations remained high. RBI may not adopt measures to support growth until headline inflation is close to its tolerance zone.
Inflation has stayed around the double-digit mark for the last 21 months, despite a series of rate rises by RBI. The central bank has raised the key policy rate by 375 basis points since March 2010. RBI is widely expected to leave the key policy rate unchanged in Friday’s policy review.
Taimur Baig and Kaushik Das, economists at Deutsche Bank, said, “In our view, significant monetary-easing measures would require another 200 basis points of disinflation, along with evidence of both a decline and stabilisation of inflation and inflation expectations. We believe unless growth and financial markets begin to deteriorate in a disorderly manner, RBI is still three to four months away from taking major easing measures.”