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Ashima Goyal, one of the external members of the Technical Advisory Committee of the Reserve Bank of India and professor of economics at the Indira Gandhi Institute for Development Research, Mumbai, talks to Neelasri Barman on inflation expectations and the central bank's likely thinking. Edited excerpts:
While headline inflation has come down RBI says it might inch up by year-end. The central bank also projects five per cent inflation for end-March. Where do you see inflation heading?
The softening in oil and gold prices will impact the Wholesale Price Index (WPI) favourably, as these prices have a larger weight. This fall in prices will be sustained because in the international market, prices were artificially high. Historically, too, we have seen commodity prices go up for 10 years and then fall. A fall in prices is positive for India because we are dependent on imports. The WPI going to five per cent is quite feasible. In inflation expectations, too, we are seeing a reversal.
But RBI also expects inflation might go up by the end of the financial year. Why will that happen?
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WPI is falling but Consumer Price Index (CPI) inflation is still in double digits. Where is the CPI headed?
The CPI gives 50 per cent of weight to agriculture and raw materials. Services also have a large share in the new index. There are problems in agricultural marketing. In India, food is a large part of the consumption base, due to which wages become linked to food price inflation. Nominal wages over-reacted to the earlier sharp rise in food inflation, leading to sharp rise in real wages. Currently, this real wage inflation has shrunk and food price inflation has also reduced. So, this time, we might not have another wage-price cycle start. More, the monsoon is expected to be normal and that will help in cooling of food prices. Besides, some efforts have been taken to improve the supply response. These factors will help the CPI to ease further.
If we're expecting WPI and CPI to ease, what is the scope for further rate cuts in this financial year?
RBI has to go carefully because inflation has been sticky for so long. It is necessary to anchor inflation expectations. It is not so much about creating an output gap, already so large. In terms of declining WPI and core inflation, RBI has room for rate cuts. There is no excess demand but because of CPI and inflationary expectations, RBI has to be cautious.
So, can we expect a further 25 basis-point (bp) cut in the repo rate this financial year?
It could also be a 50-bps cut in key policy rates if the monsoon is good and we see inflation come down further.
Why are government bonds rallying, despite the hawkish tone of RBI's monetary policy annual statement?
If RBI expects growth to be low, this means it will ease policy rates. The guidance should be interpreted as being towards easing and not towards a hawkish stance for monetary policy. If RBI underlines the services sector, which is such a large part of the economy, is also growing slowly, pulling down growth rates, then how can we interpret the guidance as hawkish? The guidance for "limited scope" is conditional and RBI gives the plus as well as minus points-the considerations that create room for further cuts. We read the data and so does RBI. If conditions improve, the room develops for rate cuts.
The rate cuts have not encouraged banks to cut lending rates. So, do you think the objective of rate cuts - to spur growth by lowering interest rates - is not being achieved?
The transmission is faster when you are tightening and slower in loosening cycles. Since credit has risen more than the deposit growth, and high government cash balances tighten liquidity, banks are not able to cut deposit rates much.
The Cash Reserve Ratio (CRR) is at a historic low. Do you think there is scope for more cuts or will RBI now use it cautiously?
If there are structural shortages in liquidity, RBI will be open to use CRR. If it is a seasonal deficit due to increase in government's cash balances, they will use Open Market Operations. In many countries the CRR is zero, so RBI might use it if it feels the need to do so.
