Bias towards action

Two issues RBI must contend with

In the Reserve Bank of India's (RBI's) June policy announcement, concerns about resurgent food inflation were highlighted, which led to a very cautious guidance about the prospects for further policy rate cuts. The June Consumer Price Index numbers seemed to validate those fears, with food prices showing signs of hardening and headline inflation rising somewhat over the previous month's reading. However, a few weeks later, as the south-west monsoon season approaches its half-way mark, fears about its inadequacy appear to have been overdone. While it is below normal in the first half, the deficiency is hardly significant; more so, rainfall has been relatively evenly distributed across the country. Cereal and vegetable prices have been under control, barring a few transient spikes in the latter. The main vulnerability has been from pulses and, even here, signals are positive, with an expansion in sown area. In short, unless the monsoon completely fails in August, the threat to inflation from food prices appears to have receded somewhat. Add to this the recent decline in oil prices and the inflation outlook looks rather favourable.

On the real side of the economy, there are obvious concerns. The Index of Industrial Production numbers still point to sluggishness. April-June quarter results of companies across the board reinforce this inference. Credit growth is painfully slow and even if borrowers are using other channels such as commercial paper, such slow growth does not suggest any momentum in production. Exports are steadily declining, even after accounting for lower prices of petroleum products. The only indicator that fits in with a relatively strong recovery scenario is the increase in indirect tax collections. But, this is clearly at odds with all other indicators, which show continuing sluggishness, with no immediate prospects of a revival in private investment, for which profitability is always a key trigger.

Against this backdrop, the RBI has to deal with two issues as it decides on its policy stance on August 4. First, is the policy rate currently where it should be, given the inflation targeting framework? It could reasonably be argued that it isn't; with the prospects of food prices stabilising or softening and oil prices doing the same, the inflation outlook suggests some headroom for a rate cut. Second, even if a rate cut were warranted, would it be prudent to do it when the last inflation reading showed an upturn? In terms of the policy framework, this could be viewed as increased tolerance for inflation, particularly when it is being driven by food prices. This argument would suggest that the status quo be maintained on the policy rate. In this newspaper's view, the first consideration must prevail over the second. With a favourable outlook on food prices, the inflation trajectory is unlikely to be very threatening. If inflation rates remain more or less at current levels, they will be well below the immediate target for 2016 and also close to the longer-term targets. Global commodity prices are unlikely to harden in the near future. Under these circumstances, the risks of sending the wrong signal are relatively low. The one spoiler, as indicated earlier, is the performance of the monsoon in the second half of the season. Which forecast is the RBI going to rely on?