Beyond a rate cut

Monetary policy panel has to consider many other variables

As the six-member Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) began its three-day review of the monetary policy on Monday, it must be grappling with a dramatically different picture of the economy from the one it considered in the last policy review two months ago. In October, crude oil prices ran up steeply and the rupee had depreciated sharply. Gross domestic product (GDP) growth in the first quarter was a robust 8.2 per cent, and even though the RBI expected growth to decelerate through the year, the expectation was that the MPC would keep the door open for raising policy rates even while maintaining a “neutral” stance. The rates were not raised as the MPC noted that both the inflation rate and inflation expectations had dialled down. Since then, both the GDP growth data as well as inflation has trended further below the RBI’s expectations. The key question then is: Is a rate cut likely on Wednesday?

There is surely an argument for a rate cut for several reasons. For one, more than the GDP data, it is the gross value added (GVA) growth rate for the second quarter that shows the weakness in the economy. After growing by 8.5 per cent each in the second quarters of FY15 and FY16, GVA growth decelerated to 7.2 per cent in FY17, a mere 6.1 per cent in FY18 and 6.9 per cent in this fiscal year despite a favourable base effect. Sequential GVA growth, too, showed that most key sectors such as agriculture, manufacturing, mining and construction decelerated. On the inflation front, the retail inflation rate steadily declined from 3.77 per cent (in September) to 3.31 per cent (in October). It is expected that the November rate will fall further — to 3 per cent, which is well below the RBI’s target of 4 per cent. This may happen because crude oil prices have dropped 30 per cent from their October 5 level and are now trending at a one-year low. The rupee too has recovered from over 74 (to a dollar) to under 70. All in all, one could argue that the MPC should cut rates because growth needs a boost and inflation is not really a worry right now, thanks to food inflation being benign. It is best that the gap between the policy rate and the inflation rate not be allowed to continue increasing.

But the MPC is caught in a dilemma here. In October, it surprised with a status quo on the repo rate, but made a crucial change in its stance — from “neutral” to “calibrated tightening”. In other words, the MPC ruled out any rate cuts in the near future. Indeed, RBI Governor Urjit Patel said it in so many words: “…calibrated tightening essentially means that in this cycle, rate cut is off the table…” If the MPC stays true to that prediction, a rate cut is unlikely. To be sure, there are other variables that deserve attention — none more than the liquidity scenario. The latest RBI data shows a liquidity deficit of Rs 620 billion in the banking system. Another key worry has to be the worsening fiscal maths and its adverse impact on private investments in the economy. The MPC thus has a lot on its plate.