Millennium Post

Raghuram Rajan shows true grit

Defying pressures from Government, businesses and markets, Dr Raghuram Rajan, Governor of RBI, has retained the current monetary policy stance with repo at 8 per cent, holding a rate cut “premature”, amid uncertainty about the evolution of disinflationary impulses as well as the “success” of this government’s efforts to hit fiscal deficit targets (4.1 per cent of GDP) in the current year.

In line with the expectation of most economists and policy analysts, the Governor holds out the prospect of a “likely change” in the monetary policy stance “early next year, including outside the policy review cycle”.  As it is, he has scheduled the next (sixth) bi-monthly monetary policy statement on February 3, 2015, but he has the option to effect a change, at any time as may be warranted.

The fifth policy review on Tuesday keeps the policy rates unchanged, repo at 8 per cent (reverse repo at 7 per cent) as also the cash reserve ratio of the banking system at 4 per cent of net demand and time liabilities.  The marginal standing facility (MSF) rate and the Bank Rate stand as 9 per cent as at present.

In his assessment of the global and Indian economy and review of monetary and liquidity measures, Dr Rajan said there is still some uncertainty about the evolution of base effects in inflation (which had helped lower CPI to 5.5 per cent and WPI to 1.78 per cent in October), the strength of the on-going disinflationary impulses, the pace of change of the public’s inflationary expectations, as well as the success of the government’s efforts to hit deficit targets.

A change in the monetary policy stance at the current juncture is premature, he said. However, if the current inflation momentum and changes in inflationary expectations continue, and fiscal developments are encouraging, a change in the monetary policy stance is likely early next year, including outside the policy review cycle. But the tenor of the Governor’s statement leaves room for doubt about the exact timing of the policy easing, given the uncertainty on inflation path and progress with fiscal contraction and investment revival.

The Governor’s statement noted that the fiscal outlook should brighten up because of the fall in crude prices. However, weak tax revenue growth and the slow pace of disinvestment suggest “some uncertainty about the likely achievement of fiscal targets, and the quality of eventual fiscal adjustment.”  The government, however, appears “determined to stay on course.”

Despite weakened activity in Q2 (July-Sep) at 5.3 per cent, reflecting moderation in kharif harvest and for agricultural growth in 2014-15, as well as the persistent contraction in production of both capital and consumer goods, RBI has retained the current year’s growth projection at 5.5 per cent. ­

Taking note of receding inflation (with current readings below the 8 per cent target for January 2015), the central forecast for CPI inflation has been revised down to 6 per cent for March 2015.

While the Finance Minister has been citing lower GDP growth and falling inflation as factors warranting a cut in key lending rate, the Governor’s statement has shifted the emphasis to investment needs.  “A rise in investment is critical for a sustained pick-up in overall economic activity”. While low capacity utilisation in some sectors may be a dampener, strong improvement in business confidence and in investment intentions should help.

At the same time, Dr Rajan has also suggested that the still slow pace of reviving stalled projects, despite government efforts, warrants policy priority.  Ongoing efforts to ease stress in the financial system should unlock resources for financing the envisaged investment push.

The policy statement is less sanguine on disinflation outlook in the current fiscal year. While the inflation reading for November – which will become available by mid-December – is expected to show a further softening. Such figures predict that after November, the favourable base effect that is driving down headline inflation, would likely dissipate. Thus, the inflation for December (data release in mid-January) may well rise above current levels.

The durability of the recent upturn becomes uncertain in the context of the 6 per cent target for January 2016, according to RBI. The full outcome of the north-east monsoon will determine the intensity of price pressures relating to cereals, oil seeds and pulses. But it is reasonable to expect some firming up of these prices with the shortfall estimated for kharif production. The medium-term outlook projections at this stage would be contingent upon expectations of a normal south-west monsoon in 2015, international crude prices broadly around current levels and no change in administered prices in the fuel group, barring electricity.

Over the next 12-month period, inflation is expected to retain some momentum and hover around 6 per cent, except for seasonal movements, as the disinflation momentum works through. Accordingly, the risks to the January 2016 target of 6 per cent appear evenly balanced under the current policy stance.

Overall, according to the RBI Policy Review, while loss of momentum in activity would probably extend into Q3 (Oct-Dec), conditions congenial for a turnaround – the softening of inflation, easing of commodity prices and input costs, comfortable liquidity conditions, and rising business confidence as well as purchasing activity – are gathering. These conditions could enable a pick-up in the last quarter (Jan-March) if coordinated policy efforts fructify in dispelling “the drag on the economy emanating from structural constraints”.

A durable revival of investment demand continues to be held back by infrastructural constraints and lack of assured supply of key inputs, in particular coal, power, land and minerals, RBI said. The success of ongoing government actions in these areas will be key to reviving growth and offsetting downside risks emanating from agriculture – in view of weaker-than-expected rabi sowing – and exports – given the sluggishness in external demand. Anticipating such success, the central estimate of projected growth for 2014-15 has been retained at 5.5 per cent. A gradual pick-up in momentum through 2015-16 would depend on a normal monsoon and absence of adverse supply/financial shocks.  IPA
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