It’s that time again. Inflation continues to remain dangerously close to double digits. Wage growth remains buoyant. Input prices increased across the board in September, and inflationary expectations remain elevated. Yet, public pressure on the Reserve Bank of India (RBI) to pause gets stronger and stronger!
Proponents of a pause would look at last week’s data and conclude the momentum of growth and inflation are slowing. They would add central banks around the world have moved to a pausing, even an easing, mode. And, this should be reason enough for RBI to call it a day.
Given the pressure on RBI from the industry and the market, this is undoubtedly a close call. But, while a pause cannot be ruled out, we expect RBI to continue on a path of monetary tightening and raise policy rates by 25 basis points at the next review. And, they would be perfectly justified in doing so. Here’s why.
First of course, the economy is slowing. But that’s not the relevant question. The question is whether or not it is slowing enough to dent pricing power across the board. There is no evidence to suggest we have reached that point yet. Yes, the momentum of core inflation slowed in September. But one swallow does not a summer make.
Several times last year, the momentum of core slowed one month, only to re-accelerate sharply the next. What was ominous, and largely missed, in the September inflation print is input prices rose across the board and are likely to pressure core inflation in time to come. Until the momentum of core slows on a sustained basis, it would be premature to conclude the economy has slowed enough.
Second, much is made of the global uncertainty. Yet, recent data flow has surprised consistently on the upside, with Euro area industrial production, for example, stronger than expected for a second month. As a result, commodity and crude prices are at their highest levels in a month.
Third, there are increasing fears that fiscal policy would not be as tight as once thought. The looser the fiscal conditions are, the higher the commodity prices are, the tighter the monetary conditions would have to be.
And, here’s the irony: The sharp currency depreciation over the last two months has meant that despite the rising policy rates, overall monetary conditions have actually loosened over the last month! The weaker rupee has increased the domestic cost of tradables and thereby, undercut some of the impact of previous rate increases. The implication is policy rates need to do more of the heavy lifting.
For all these reasons, we expect (and hope) the central bank would ignore the rising chorus and continue raising rates. To pause now would be to undo much of what was courageously done in the recent past.
The writer is India economist, JPMorgan
