The October policy statement of RBI stating “It is important to note that even if the monetary policy stance shifts further towards addressing growth risks going ahead, the objective of containing inflation and anchoring inflation expectations is not de-emphasised” leaves some room for interpretation.
For any material change in monetary policy, we require the twin (current account and fiscal) deficits to narrow, inflation to ease and growth to pick up. The current rupee depreciation of 3-5% could reverse the appreciation impact of the rupee, which pulled down October inflation. Apart from subsidy overshoot and weak tax collections, the one-off sources of revenue ie. auction of mobile telephony spectrum and divestment have fallen short of targets. The fiscal problem is far from satisfactory and there’s a high probability that even the revised FY13 deficit target of 5.3% of GDP will be breached.
Post the positive nod in Parliament for FDI in multi-brand retail, the government in all its zest is trying to push through with other reforms, however, it remains to be seen if FDI in insurance and banking, company law amendment, FDI in pension scheme etc get the same results.
Further, the removal of bottlenecks and streamlining policies surrounding mining, land acquisition, power sector and uniform goods and services tax will be key to attract the targeted additional investment.
November WPI inflation came at 7.24%. Agricultural inflation seems to be stable, with expectation of a good winter (Rabi) crop controlling the drought impact of rising agriculture commodity prices. This could be the beginning of a gradual toning down of inflation expectations.
On the global front, in addition to the distortions caused by hurricane Sandy, data surprises were fairly balanced.
In the US, the labour market data was better than expected. On the policy front, little progress was made last week towards a compromise on the ‘fiscal cliff’, but as in the past, we feel this to be resolved with some compromises on key positions. The US Fed is expected to continue its outright purchases of treasuries and mortgage-backed securities thereby continuing to add to global liquidity and investments.
There has been a persistent higher LAF (liquidity adjustment facility) number as well, which indicates a structural liquidity deficit in the system, and has rightly resulted in the resumption of open market operations by RBI. Improvement in liquidity is key for monetary policy easing as rate cuts alone will not be able to transmit into lending rate cuts. Given the above backdrop we expect RBI to cut CRR by 25 basis points on December 18 to ensure adequate liquidity and wait for inflation data while having a cautious watch on government’s ability to take prudent quantitative and concrete steps leading towards fiscal discipline, before actioning a rate cut.
The author is head-global markets group, IndusInd Bank
