RBI policy preview: May be right, but not perfect conditions to cut interest rates

There is a consensus in the market for a 'hold' in the interest rate, but the MPC could also take a call for a 25 basis points cut in the repo rate. There are still inflationary risks on the horizon.

By Anand Adhikari  
Tuesday, February 5, 2019

After a long time, the retail inflation or the Consumer Price Index (CPI), which the Reserve Bank of India (RBI) tracks to set interest rates, has been touching the new lows. In December, the CPI recorded a 2.19 per cent rise, which is well below the targeted rate of 4 per cent. The CPI is on a downward spiral since July when it was above 4 per cent. There may be a change in the RBI's stance from 'calibrated tightening' to 'neutral' in the monetary policy review, which will be out on Wednesday this week. There is a consensus in the market for a 'hold' in the interest rate, but the MPC could also take a call for a 25 basis points cut in the repo rate. There are still inflationary risks on the horizon. Take a look:

Still far away from low and stable inflation

The RBI has already changed the inflation projections six times in a year. The latest projection made in December has pegged the CPI inflation between 2.7 per cent to 3.2 per cent in the second half (October-March) of 2018-19. The headline inflation though at 2.19 per cent is low and well within the targeted level, but there is no certainty that inflation will remain low. Till July last year, the CPI ruled above 4 per cent. It is only in the last five months that inflation has seen a steep downward trend because of food and crude prices. The inflation should be low and stable for a long time for a cut in the interest rates. 

Core inflation is sticky  

The core CPI inflation, which is without food and fuel, is still sticky. In fact, the core inflation has been clocking a 5-6 per cent growth rate for the last 12 months. The core inflation is the right indicator as it doesn't take into account change in food and fuel prices, which are highly volatile. 

Fiscal prudence not in sight 

The fiscal deficit target of 3 per cent of GDP is still few years away. In fact, when the BJP-led NDA government presented its first budget for 2014-15, the Finance Minister Arun Jaitley had set a roadmap to achieve 3 per cent in 2016-17.  The consistently high fiscal deficit is inflationary for the economy. Given the focus on farm loans and other social schemes, the fiscal deficit target of 3.4 per cent is likely to be breached further. 

Volatile crude prices

The crude oil prices are not stable. It went up to $85 a barrel in October last year and plunged to $55 in January this year. The prices are again on the rise because of US sanctions on Venezuela, which is one of the major oil exporting countries. The oil prices in February firmed up to $60 per barrel. So, there is a risk of crude oil prices rising because of supply factors.

Election round the corner 

The elections spending always create more money supply in the market. The general election in April-May will raise the inflationary expectations. In fact, the election dole outs (by Centre, state governments, and political parties) will create supply pressure. 

Also read: Modi govt keen to hand out up to Rs 4,000 to farmers before polls  

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