The balance tilts: Sajjid Chinoy

On the surface, the Reserve Bank of India (RBI) monetary policy was a non-event, with the central bank inaction being widely anticipated. To be sure, RBI re-affirmed its accommodative stance, in that it would continue to look for space to ease rates to the extent the data allow.

Yet, beneath the surface, there were important developments. Like some other central banks around the world, RBI has sensed that the balance of inflation risks has begun to change. Since the April review, crude oil prices have jumped almost 30 per cent, global commodity prices are up 15 per cent, several food prices have hardened, rural wages have begun to firm and the Pay Commission looms. As a consequence, inflation in the April-June quarter is likely to average closer to 5.5 per cent - above both what RBI had anticipated and next year's 5 per cent inflation target. To be sure, it's not all a one-way street. A normal monsoon should provide some disinflationary impulses, though it must be said there is no direct, easy correlation between the strength of the monsoon and food inflation. Also, capacity utilisation remains low enough that manufacturing pricing power generally remains muted. But sustained input price increases - whether from wages or oil - could cause the margin cycle to turn, and eventually put pressure on output prices. Already, core Consumer Price Index (CPI)-based inflation has been stuck at 5.5 per cent for the last 16 months.

What all this suggests is that the risks to inflation, which were to the downside at the start of the year and balanced a quarter ago, have moved to the upside, and constrain the amount of space monetary policy has to manoeuvre. We are virtually at the end of the policy-easing cycle. Instead, markets should expect that RBI's primary focus this year will be to ensure greater transmission of previous easing into wholesale and bank rates.

How then do we get to 4 per cent inflation by 2018, under the inflation targeting framework, one may legitimately ask? The key will be supply side reforms. Food inflation over the last two years is a great case in point. Despite successive droughts, food inflation has moderated from 10 per cent to 6 per cent on the back of better food supply management and restrained support prices - for which the government deserves enormous credit - and some global benevolence. That should provide a template for inflation, more generally. Broad-based supply side reforms that increase the economy's productive capacity - both capital and labour - are the only way in which there will be no trade-off between RBI's ambitious inflation target and the government's ambitious growth target down the road.

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Sajjid Chinoy
Chief India Economist, JPMorgan