Stage set for lowering policy rates

The RBI’s own guidance to the markets in the past, the softening of headline inflation and dampening of growth, has led to a broad consensus among analysts — the RBI will deliver a rate cut in its third quarter review of monetary policy, scheduled on January 29.

The FII activity in the stock market, which also influences the rupee’s value in the forex market, suggests that the markets, too, are factoring in a rate cut in the upcoming quarterly review. The average daily net FII flows between September 2012 and (the first half of) January 2013 was double that in January-August 2012. The Governor, however, has watered down hopes of a rate cut recently, by expressing concerns over high consumer price inflation.

ONUS ON RBI

The market’s difficulty in gauging RBI’s mind and actions has increased of late, with the central bank vacillating between wholesale and retail inflation as its policy anchor. While it makes sense to anchor inflation at the consumer level from the common man’s perspective, the monetary authority has only limited influence on consumer price outcomes.

The demand-side pressures on inflation, captured through core inflation, have subsided significantly in the recent times. The latest reading on core inflation, at 4.2 per cent in December 2012, is at a three- year low. This should embolden the central bank to deliver a decisive rate cut. However, by highlighting its discomfort with double digit inflation at the retail level, the central bank is trying to tone down expectations of a significant rate cut. While inflation is one side of the story, the growth aspect also needs to be taken into consideration in shaping monetary policy. Growth concerns had prompted the RBI to lower policy rates by 50 basis points in April 2012, and since then it has maintained the status quo . Policy stasis was the major reason cited by the Reserve Bank for not softening rates any further. With P. Chidambaram taking charge as Finance Minister in late July 2012, policy stasis has given way to a number of progressive measures.

REFORM MEASURES

Beginning September last year, a spate of policy initiatives has been taken. A key initiative has been in the direction of reviving investments. Investment, especially in infrastructure, has faced a number of roadblocks at the implementation stage in recent times, and has been the bane of India’s growth story.

Taking cognisance of the need for inter-ministerial coordination to secure the necessary clearances, the government has recently set up the Cabinet Committee on Investment (CCI). The CCI has the mandate to seek inter-ministerial cooperation and coordination to expedite clearances for infrastructure and manufacturing projects over Rs 10,000 crore.

The CCI is a diluted version of Chidambaram’s proposal to set up the National Investment Board (NIB). The NIB was supposed to be a one-stop window for various clearances. The overriding power of NIB was strongly opposed by the Environment Ministry, and the government instead has set up the CCI.

The Finance Minister has tried to gain the confidence of the rating agencies by reiterating that he will not breach the revised fiscal deficit target of 5.3 per cent in the Budget. A couple of days back the government allowed oil marketing companies (OMCs) to raise diesel prices by 50 paise per litre every month till their losses are met. This pragmatic approach to reduce fuel subsidies follows a 12 per cent hike in diesel prices in September 2012.

These steps, coupled with other decisions such as permission for 51 per cent FDI in multi brand retail, subject to approval from the State government concerned, and launching of Aadhar-based cash transfer system on January 1, should convince the central bank that the government is serious about reviving growth.

GLOBAL SITUATION

The turbulence in the global economy, on account of the sovereign debt problem in Europe and fiscal cliff in US, has ebbed somewhat. However, softer oil prices, because of subdued growth in major parts of the world, have not materialised. Geo-political risk has kept the price of crude higher than what demand and supply would suggest. The price of the Indian basket of crude averaged $117 per barrel between January-May 2012.

Except for brief period during June to mid July 2012 when came down $97, it averaged $108 per barrel in the subsequent months. The much-needed alignment of domestic retail prices to international crude prices will help in rationalise use of petroproducts.

The World Bank, in its report on ‘global economic prospects’ released on January 15, has indicated that though global growth is expected to be weak in 2013, the downside risks have subsided. Resolute action on a range of issues — increase in debt ceiling in the US, tensions in Asia and confidence crisis in Europe — could lead to stronger growth in high-income countries, with positive externalities for developing country exports. India’s exports have fallen consecutively for the past eight months. India can do little if global growth remains sluggish. In such a situation, the RBI should do all it can to revive domestic demand.