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The rupee's stability has once again triggered the chatter on reversal of July's tightening measures. However, most economists maintain that the in order to normalise monetary policy environment, the marginal standing facility needs to be cut by another 25 basis points to 8.75% and the repo rate hiked by 25 basis points to 7.75%. On the face of it, there is nothing flawed about this argument as the currency has stabilised so reversal of July's measures would be justified. But narrowing the gap between the MSF and the repo rates to 100 basis points is unlikely reverse macro-imbalances. A section of economists believe that RBI should retain MSF rates at the current level if not higher as real interest rates have turned negative again for savers if one looks at the CPI, which is near double digits. The currency, as is well known, has stabilised more due to global factors than local.
Other than the currency, macros are still looking stressed. For starters, estimates of a modest 4.5% growth in GDP also appear to be at risk. The bumper crop this year may push up agriculture growth to over 3% levels, but this growth will do little to tame inflation as a large part of the CPI inflation has been driven by fruits and vegetables. Tirthankar Patnaik of Religare Institutional Research believes that the modest hike in support prices of rabi crops won't help much either as Rabi crops account for 1.87% of the WPI basket and 4-5% of the CPI basket. Thus, while the impact on wholesale inflation would be negligible, that on CPI would likely be 50 basis points based on September 2013 prices, ceteris paribus", he says. With retail inflation staying high, he does not rule out a rate hike in December.
Over the last four years, the divergence between CPI and WPI has increased and yet it's the WPI which policymakers use to assess inflationary pressures. Given that the savings rate has been falling more sharply than the investment, Morgan Stanley's Chetan Ahya and Upasana Chachra believe that the focus of policy makers should have been on the real rate for savers, as a significant part of WPI represents intermediate/input prices and not final consumption product prices. The RBI has been focused on lowering rates by looking at the WPI, even though what has hit savings is a very high CPI. As a result, the RBI has not been able to trigger a revival in investments despite rate cuts. For four years now, real interest rates have remained negative for savers. Low real rates are good for growth, but not when real rates are depressed due to high inflation.
According to Morgan STanley, this unpleasant mix can be best avoided with an overall anti-inflationary thrust in monetary policy, which may accommodate growth needs only when inflation stays contained below the 6% threshold.
