There has been much arguing and hoping for the Reserve Bank of India (RBI) to ease monetary policy with a cut in the repo rate on October 30. The key logic is that the government has delivered on the fiscal side, something RBI had been repeatedly indicating as a necessary condition. True, some sentiment reversal has happened on account of the recent flurry of executive measures. However, we remain sceptical on how much these policy announcements will be able to sort much of India’s current problems.
The only policy change likely to have a tangible impact on the fiscal issue is the diesel price increase, and the cap on the number of subsidised cooking gas cylinders. And, the extent of gains from these measures could be eroding, with global crude oil prices continuing to hold up and with the rupee to dollar rate again on a depreciation mode.
So, how do we think RBI is going to react? I think RBI might not be sanguine on the fiscal consolidation process. My estimate is that fiscal deficit as a proportion of gross domestic product (GDP) could still be at 5.9 per cent, and conditional on the government collecting the full amounts budgeted for public sector units’ disinvestment and telecom spectrum auctions. Further, I estimate the current account deficit can only correct to four per cent of GDP in this financial year, compared with 4.2 per cent last year. Thus, for RBI, we have a situation where the twin-deficit issues are yet to be resolved, implying aggregate demand remains high.
All these point to a continuing uncomfortable scenario on inflation from RBI’s perspective. Core wholesale price index inflation is likely to come down but this might not suffice, as RBI could be shifting its focus to retail inflation. This is because it thinks food and fuel inflation are no longer transitory and the share of these items in the retail consumption basket is high.
Thus, inflation as a problem is entrenched in the Indian system, not providing much breathing space for RBI to cut the repo rate immediately. However, a cash reserve ratio cut is still likely, enabling some room to the banking sector to reduce costs and, hence, lending rates.
(The author is chief economist at Kotak Mahindra Bank. The views expressed here are his own, not those of his organisation)
