Business sentiments have improved substantially since the new government assumed office and embarked upon a series of reforms and schemes aimed at boosting growth. Moreover, inflation has eased considerably on account of several factors, including a persisting weakness of consumer demand, fuelling calls for an early change in the stance of monetary policy to support a revival in growth.

This may be premature as inflation is expected to rise to levels of around 7 per cent by the end of this fiscal as the base effect wanes.

The government has announced various growth-boosting measures in the last six months, which has sustained the improved sentiments of Indian businesses and foreign investors, as indicated by the healthy pick-up in new project announcements in Q2FY15 as well as FDI and FII flows in the current fiscal.

Nevertheless, the economic growth momentum appears to be faltering in the second half of 2014, on account of a sluggish farm sector, lack of pick-up in consumption demand and slowdown in growth of exports.

Retail inflation down At the same time, a number of factors have contributed to a decline in retail inflation. Such factors include a favourable base effect following the spike in food inflation in 2013, the persisting weakness in consumer demand, moderate revisions in farm support prices and lower growth of rural wages in the current fiscal. The decline in global commodity and domestic fuel prices have also aided the fall in inflation, albeit to a smaller extent.

CPI inflation, which has been designated the nominal anchor for monetary policy, stood at 5.5 per cent in October 2014. This was below the January 2015 target of 8.0 per cent as well as the January 2016 target of 6.0 per cent according to the glide path announced by the Reserve Bank of India. However, with a waning of the base effect, CPI inflation is likely to revert to levels of around 7 per cent in February-March 2015.

Moreover, a revival in domestic demand conditions may fuel inflationary pressures, particularly if the current moderation in global commodity prices does not sustain on account of geopolitical tensions and additional liquidity infusions by central banks. Therefore, despite the lag associated with policy transmission, the RBIis likely to refrain from monetary easing in the immediate term.

Towards revival

Cuts in the Repo rate are unlikely to prove either necessary or sufficient to boost economic expansion. With continuing excess capacities in a number of sectors, a cut in interest rates is unlikely to spur a revival in the capex cycle in the near term.

Furthermore, lower interest rates are unlikely to revive project implementation, with several projects stuck on account of issues related to land acquisition, availability of feedstock, clearances and so on. A concerted effort by the Centre and the State governments to remove such impediments is likely to produce a more durable revival in growth.

In the baseline scenario, factoring in a normal monsoon forecast for 2015, crude oil prices sub-$95/barrel and relative stability in the rupee-dollar exchange rate, we expect the central bank to embark on a rate easing cycle in Q1FY16. Nevertheless, Repo rate cuts are likely to be limited to 50 bps in 2015. While this may sustain business spirits, it may not stimulate a sharp improvement in economic growth in the absence of continued reform measures as well as the successful implementation of the reforms and new schemes announced by the government.

The writer is the MD and CEO of ICRA Ltd

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